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Are Mortgage Rates Bubbling Up Trouble for Canadas Metropolitan Housing Sector?

Louis, Rosmy J and Brown, Ryan and Balli, Faruk (2009): Are Mortgage Rates Bubbling Up Trouble for Canadas Metropolitan Housing Sector?

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Abstract

This paper determines how mortgage rate and income shocks affect new and resale housing prices, housing starts, and housing sales in Canadas metropolitan areas. We assess the variance decompositions and impulse response results to mortgage rate and income shocks. An additional set of VARs is estimated to document whether the stock price, as an alternative source of investment, reduces the importance of the mortgage rate. Our results show that the importance of the mortgage rate and income varies significantly by metropolitan area and to a lesser degree, by the component of the housing market examined. More precisely, we find that: 1) two of BCs major metropolitan areas housing markets, Vancouver and Victoria, are vulnerable to interest rate bubble;. 2) Mortgage rates, and by extension the Bank of Canada monetary policy, seems to have little direct impact on Albertas major metropolitan housing markets, Calgary and Edmonton, while income can be expected to have a drastic effect; and 3) The housing markets of Ontarios major metropolitan area and Canadas Capital Region are prone to mortgage rate bubbles, but the impact is dampened due to their connectedness to national financial markets. What these results mean in terms of policy-making decision is that close attention needs to be paid to housing markets in Canada that are vulnerable to spikes in mortgage rates as we are coming out of the recession provoked by the housing market meltdown in the United States. Although it is true that Banking regulations in Canada have helped weather the storm, with the massive fiscal stimulus implemented in both Canada and the United States, eventually strong aggregate demand may build up pressure on prices to rise and interest rate will have to increase in order to maintain price stability, thereby causing troubles for mortgagees.

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