Is Canada Poised for a Minsky Moment?

Paul Krugman, in his excellent new book, End This Depression Now, has an excellent analysis of the dangers of high private debt levels and overleveraging. Krugman makes the point that, when debt levels get too high, the economy is vulnerable when things go wrong. This is the so-called Minsky Moment, named after economist Hyman Minsky – an economic phenomenon where debtors are forced to rapidly try to liquidate assets as they attempt to deleverage in a downturn. Of course, collectively they cannot and Fisher’s debt deflation spiral sets in.

Before the 2008 recession, household debt levels in the USA were above 100 percent of GDP. Today, In Canada, household debt levels are running close to 95 percent of GDP (see graph below).

The fear of a Minsky Moment has prompted both finance minister Jim Flaherty and Bank of Canada (BoC) governor Mark Carney to issue warnings to Canadians over the last few months on the dangers of high debt levels.

There can be no doubt that private debt levels in Canada are too high. Many Canadian families would have difficulty managing their debt loads if a serious economic downturn occurred. The escalating problems in Europe, coupled with continued uncertainty in the USA and elsewhere, give good cause for concern. In addition, should the BoC need to raise interest rates, many debtors would find themselves in great difficulty.

Household debt runup in Canada has accelerated following the 2008 recession. Part of the problem is many Canadians have been forced to assume debt because real wages are either stagnating or falling. With nominal wages rising only 1.8 percent and inflation running at 1.9 percent, many householders must use debt financing to maintain their standard of living. In addition, structural employment changes, where labour has shifted from high-paying manufacturing jobs to lower-paying service jobs, has meant many workers have had to settle for lower nominal wages.

Wage readjustment and stagnation has implications for how quickly Canadians can deleverage their debt positions down to more manageable levels. It will be interesting to see if Canada can avoid the undesirable consequences of a Minsky Moment should the economy take a downturn.

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