Canada’s love affair with leverage since the mid-2000s has been nothing short of extraordinary. National debt – including debt owed by households, non-financial corporations and governments – rose by CAD$3.6 trillion (nominal) from 216% of GDP in 2005 to 302% of GDP in 2018. Canada had the 7^th highest level of national indebtedness globally in 2018. Divided by the total population, Canadians currently owe around $180,000 per person (Table 1). Canada’s economy is now highly exposed to potential negative shocks to income and asset prices and will remain so for the foreseeable future.

Table 1: Canadian debt by sector, 2018

Source: BIS Statistics; Statistics Canada (population).

How did we get here?

The ratio of government debt to GDP tends to rise during economic downturns as governments run significant budget deficits to buttress weak aggregate demand. While Canada’s 1990-92 recession saw a significant rise in government indebtedness, this was followed by a long period of fiscal consolidation by the federal government and most of the provinces. Also, household and corporate indebtedness was steady over the 1990s. As a result, Canada’s overall national debt peaked at 252% of GDP in 1993, but thereafter it gradually retreated to 216% of GDP by 2005 (Figure 1).

Households began to significantly expand their balance sheets through leverage after 2000, as did non-financial corporations after 2005. Successive federal policy changes and financial innovations (e.g., home equity lines of credit, HELOCs) made credit easier to access. Falling nominal and real interest rates also made it cheaper for households and firms to service higher debt principals. Government borrowing also ramped up sharply from 2008 due to the 2008-09 recession.

Taken together, national indebtedness jumped to 260% of GDP in 2009, a 45-percentage point increase in the debt/GDP ratio in only four years. However, unlike the experience of the 1990s, Canadian indebtedness continued to rise significantly for many years after the 2008-09 recession – and it rose across allsectors (Figure 2).

Figure 1: Canada borrowed heavily before, during and after the 2008-09 recession

Figure 2: Canada's unchecked love affair with leverage - across all sectors

Canada is a world leader in post-2007 private sector indebtedness

In many countries burned by the 2007-08 global financial crisis (GFC), households and/or corporations subsequently took advantage of extraordinary monetary policy support – ultra-low interest rates and asset purchases – to reduce debt. Canada took the opposite approach. Canada’s increase in private sector indebtedness was the 4^th largest globally over 2007-2018, following the lead set by Hong Kong and China (Figure 3). There has also been no post-recession fiscal consolidation in Canada, unlike what happened after the 1990-92 recession.

Figure 3: Canada's post-2007 increase in private sector indebtedness is the 4th largest globally

Conclusion

Canada’s post-2005 leverage cycle is extraordinary for its size, length and breadth across the private and public sectors. The $3.6 trillion (nominal) increase in national debt over 2005-2018 has contributed to asset price inflation, including house prices in Canada’s gateway cities. Canada is now the 7th most indebted country in the world.

An optimistic interpretation is that borrowers have great confidence about future economic prosperity and asset values. Such optimism may turn out to be justified if interest rates and unemployment remain near historical lows, if the terms of trade remain near historical highs, and if Canada’s anemic productivity growth were to improve leading to an acceleration in real wages.

A less sanguine interpretation is that Canada’s sleepy macro-prudential and fiscal frameworks have not effectively and timeously checked the growth of leverage across the financial system. For the foreseeable future, Canada’s economy will be highly exposed to two key risks. First, a negative shock to household or corporate income growth (e.g. slower productivity growth and real wages, a rise in unemployment, or a fall in the terms of trade), or a rise in interest rates and bond yields, or a downgrade in corporate credit ratings, would make servicing loans more difficult. Second, a negative shock to asset prices could push some borrowers “underwater,” a situation where an asset’s market value is less than the outstanding loan (also known as "negative equity"). The intersection of these two situations tends to be associated with asset fire sales and defaults, as financial history and the GFC demonstrates.

By any standard, Canada’s economy is highly leveraged. This predicament underscores the importance of belated actions by the federal government to tighten mortgage qualifying rules in 2017 and 2018. It also underscores the urgency of structural reforms to raise productivity growth and real wages to facilitate debt consolidation and reduce the economy’s vulnerability to adverse economic developments going forward.