Asymmetric Risks to the Economic Outlook Arising from Financial System Vulnerabilities

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When financial system vulnerabilities are elevated, they can give rise to asymmetric risks to the economic outlook. To illustrate this, I consider the economic outlook presented in the Bank of Canada’s October 2017 Monetary Policy Report in the context of two key financial system vulnerabilities: high levels of household indebtedness and housing market imbalances. Uncertainty on the profile of consumption by indebted households—and, therefore, risks to growth in gross domestic product (GDP)—arises from higher interest rates and from recent changes to the Office of the Superintendent of Financial Institutions’ B-20 mortgage underwriting guideline. I use non-linear Bayesian techniques to capture the potential amplification of negative shocks in a vulnerable environment. I find that the materialization of larger-than-expected impacts on consumption from higher interest rates and/or the tighter mortgage qualifying criteria would imply asymmetric risks to GDP growth.

DOI: https://doi.org/10.34989/san-2018-6