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Walking the Fine Line of Debt and the Economy

The fact that our household debt to income ratio has now hit the high percentage of 163% has had many – including economists, analysts, government officials, and consumers – on the brink of panic the past week or two. But while common sense may tell us that now is the time to rush out and start paying off all that debt, that could be the very thing that leads up to financial ruin. The problem is that when it comes to our debt, our economy needs it. In fact, in order to keep the economy churning, many of us need to stay in at least a little bit of debt.

It’s an issue that as Canadians, we’ve been facing for the past couple of years – the fact that we simply have too much debt. It’s become such a problem that it’s been called by many the number one risk to our domestic economy. But while we’ve all been panicking, we’ve also had that nagging little voice in the back of our minds telling us that it’s that very debt that we need. If we didn’t have it after all, consumers wouldn’t continually be putting that owed money back into the economy, banks wouldn’t continue to profit which means they wouldn’t be able to continue to lend, and things could very well slow to a very sluggish pace.

Hence the fine line. Paying off debt too quickly can cause a slowdown on the economy. But there’s also no doubt that if we’re in too much debt, than we can’t afford to put money anywhere else in the economy and again, we have to stop borrowing and banks have to stop lending. Something else that could bring the economy to a halt.

But the problem is more exacerbated now than it has been in the past couple of years because the housing market is starting to cool down at the same time. When that market is hot, consumers are still making large purchases in the way of homes and property, to make up for the fact that we either have too much debt, or are paying it off too quickly. Now though, that market can’t be looked to for the support that maybe it once could. The Canadian mortgage rules that went into effect in July have kept many out of the market completely; resulting in far fewer homebuyers and so, less money swirling around in the economy. Add that to the fact that consumers could also stop spending at the same time, in order to focus on debt repayment, and it could spell real trouble.

Dawn Desjardins, assistant chief economist at RBC, doesn’t think we’re there yet. She doesn’t think that consumers “are going to pull back on spending to such a significant extent that it destabilizes the economy.” She gives a number of reasons for this, including a fairly stable labour force, an increase in wages, low borrowing costs that will continue to keep consumers borrowing, and a sound financial system.

She does add though, that because of this fine line we’re walking, it’s more important than ever for the Bank of Canada to take household debt into consideration when setting stimulus policy such as interest rates. That’s probably not going to be a problem.

Mark Carney has been one of the many in the chorus of voices saying that we’ve taken on far too much debt, and that we’re simply in over our heads. After announcing on Tuesday that the overnight rate would remain at 1 per cent, he also stated that the economy, “is expected to pick up and return to full capacity by the end of 2013,” which means that we likely won’t see an increase in rates until the end of next year.

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