Wednesday, 23 January 2013

Canadian households continue to borrow from the rest of the economy

There is considerable coverage in the press about the level of debt being held by Canadian households, which continues to grow in both absolute terms and relative to income. There is more to this story. A key concept to understand is that someone’s debt is someone else’s asset, and therefore savings. For example, most mortgage debt in Canada is financed by bank deposits, which are someone else’s savings.  Therefore, total debts must equal total loan assets, resulting in no net debt.  More generally, net financial assets (for a closed economy or the world as a whole) must equal zero. This is an accounting truism. Financial assets can include both debt or equity.

Even though financial assets net to zero, they can be in surplus or in a deficit at the sector level.   The economy can be divided into different sectors, such as by households, corporations, governments and the external (foreign) sector. The balance sheet of each sector provides the stock of financial assets at a given point in time, while changes in the stock of financial assets over time (using book values) result in financial flows by sector.

The graph below shows financial flows in Canada since 1991 as a percentage of GDP.  What is striking is Canada’s deep fiscal deficits in the early to mid 1990s. These deficits were financed by surpluses in the corporate, household and external sectors.  However, by 1997, after years of fiscal austerity, government deficits became fiscal surpluses.  These fiscal surpluses financed the household sector which moved into deficit territory the same year.  Fast forward to the 2009 recession and government surpluses disappeared, with governments and households running deficits financed by corporate savings as well as the external sector (mostly via trade deficits).

The corporate sector experienced financial flow surpluses for most of the period examined.  Normally in a capitalist economy households save and corporations invest household savings in non-financial assets, such as in non-residential structures, machinery or equipment. It is not clear why the corporate sector has been able to maintain a surplus position. Perhaps, because corporations retain their profits and reinvest them instead of paying out dividends, with household benefiting via capital gains not captured in financial flows.

If Canadian households begin to deleverage, as they have in the United States, household financial flows will move into surplus.  With net financial flows must balancing, some other sector of the economy will need to adjust their financial flows by moving into a deficit, by either borrowing more or issuing more equity.  In the United States, household financial flow surpluses, as a result of household deleveraging, were balanced by larger government deficits.  If and when Canadian households begin to deleverage, it will be important to the economy what sector adjusts to allow overall financial flows to balance.


  1. What do you think this means for fiscal policy if anything?

  2. D Ford. Good question. Sectoral balance are not economic models and do not explain the behavior of economic agents, including the behavior of governments and therefore fiscal policy. However, since sectoral balance always do balance, they constrain (but do not explain) possible economic outcomes, including those of fiscal policy. For example, governments can only run deficits (borrow from the rest of the economy) as long as in aggregate the rest of the economy (including the foreign sector) is saving more than it invests (which my definition result in financial asset surpluses).