Bank of Canada governors don’t make it to the territories all that often, at least not in an official capacity. Stephen Poloz flew to the Yukon in January to see the northern lights, but it was too cloudy. He was back in Whitehorse last week though, this time to deliver an update on the economy. In the Land of the Midnight Sun, “Sunny Stephen”—a moniker the central banker has earned for his perpetual optimism—lived up to his nickname. After outlining some risks to the bank’s outlook, Poloz painted a picture of an economy more or less unfolding as it should. “We have the right to be optimistic,” he said.
No surprise there. Poloz has maintained his upbeat tone since he took the helm at the bank three years ago. But his Whitehorse speech stands out for the rare appearance of an unusual creature that popped up near the end of his remarks. See if you can spot it:
“Companies are run by real people, who risk real money in creating jobs and economic growth. Hesitating to do so in the face of uncertainty is only human. Workers who lose their jobs as a result of low oil prices may need to contemplate moving to another part of Canada, and layering the Alberta wildfires on top only increases the human burden. Economic adjustment processes that seem so ordinary in our models are painful, costly and take time at the human level.”
Hold on. Did Poloz just discover the economy has humans in it?
To be fair, the governor prefaced his observation by acknowledging that the economic processes he talks about can sound mechanical. But it really is rare to hear Poloz talk like this. The word “human” doesn’t appear in the transcripts of any of Poloz’s nearly 50 speeches since 2013, at least when discussing the Canadian economy. (He did once reference the human cost of the Great Depression.)
This is not just a question of semantics. It gets to the heart of one of the main criticisms of how economists view the world. The Bank of Canada, like all policy-makers, relies heavily on macroeconomic models that draw on the past to forecast how the economy will perform under various conditions in the future. That in turn helps to guide it in setting interest rates. Yet Canada’s economic story has consistently failed to unfold as the bank’s models have suggested. The low loonie and cheap oil have not driven a recovery in business investment, which stalled out in 2012 and is now below where it was before the recession began in 2008. Exports of non-energy goods have greatly lagged expectations. Inflation has failed to respond to lowered interest rates. In fact, the only parts of the economy that have shown any signs of life are consumers and households, who have responded to low rates and cheap debt by gorging on new vehicles and real estate.
Why have the bank’s models failed? Some would argue it’s because they were doomed to. Lurking at the heart of traditional economic models for decades has been a being who might as well hail from another planet—homo economicus, an artificial construct that assumes that people, be they homebuyers, CEOs, workers or investors, are well-informed, rational participants in the economy.
In recent years, however, a new field of thinking has emerged that embraces the fact that people are flawed, impulsive, emotional creatures who regularly engage in activities that go against their best interests. Richard Thaler, an economist at the University of Chicago and the father of behavioural economics, put it best in 2009, during the depths of a financial crisis that traditional economic models had completely failed to foresee: “Conventional economics assumes that people are highly rational—in fact super-rational—and unemotional. They can calculate like a computer and they have no self-control problems . . . Real people are not like that.”
Make no mistake, Poloz is keenly aware that conventional economic models are broken. In the Bank of Canada’s 2013 annual report, released in early 2014, he said as much, acknowledging that the unusual circumstances of the post-financial-crisis world mean the performance of the old models “has weakened.” Instead, he vowed the bank would put more emphasis on anecdotal evidence, “real conversations with real Canadians making real economic decisions.”
And yet since then, Poloz’s forecasts have continued to prove overly bullish, suggesting either the Bank of Canada has maintained its reliance on macroeconomic models, or that he’s not really listening to what those real people have to say.
Or maybe he just doesn’t like what he’s hearing. Earlier this month, an exasperated Poloz finally strayed from his reassuring message on the housing market. In recent years, he has maintained that despite rising household-debt levels, there was no evidence of bubbles. As recently as last year, he said he saw “no excess” and that the market is in line with demographic demand—in other words, the housing market was behaving rationally. But now, in the face of 25 per cent annual house-price gains, ample evidence of reckless lending and households debt levels that make Americans circa 2005 look frugal—all fuelled in large part by ultra-low interest rates and expectations that those low rates are here to stay—he has finally been forced to confront the utter irrationality gripping Canada. “We see a rate of price increase [in Vancouver and Toronto] that would be very difficult to match up with any definition of fundamentals,” he said. “You don’t need a formal model or a specific analysis to make that assertion.”
It’s certainly a sign that Poloz is wising up to the gremlins in the machine. The only question now is what impact this discovery will have on Bank of Canada policy.