[ chart : home equity withdrawal and home renovations ]. 2 these expenditures can " accelerate " a rise in house prices, reinforcing the rise in collateral values, access to additional borrowing, and thus a rise in household spending. of course, this accelerator effect can also work in reverse : a decrease in house prices tends to reduce household borrowing capacity, and amplify the decline in spending. finally, a significant increase or decrease in house prices from historic norms – that is to say, the inflating or deflating of a " bubble " – can have an impact on the real economy. in a nutshell, bubbles are costly ( in both directions ) because they distort decision making and impede the optimal allocation of resources. as a bubble develops, people tend to build and purchase more housing than would be the case when prices reflect fundamentals, and lenders may divert investment to housing from alternative, more productive opportunities. when the bubble bursts, decision making is again distorted, and both households and lenders suffer the consequences. this boom - and - bust cycle can prove very costly to the economy. the appropriate monetary policy response to these bubbles is the focus of considerable debate. the bank of canada considered this issue in the period preceding the renewal of the inflation targeting agreement with the government, 3 and we continue to examine it. these three effects – the direct effect on inflation, the effect on consumption, and the effects of an inflating or deflating bubble – carry important implications for monetary policy, implications we consider when we set policy to achieve our 2 per cent inflation target over the medium term. let me now turn to some challenges for the bank, other policy - makers, lenders and investors, with regard to the promotion of a sound housing market in canada. challenges for policy - makers and financial markets the first challenge is to continue to ensure that policies encourage the right kind of practices and innovation in mortgages and home equity lending. in this regard, it is extremely important that sound lending standards be consistently applied – even in " good times. " we should be wary of innovations that encourage price run - ups beyond what fundamentals would justify ; many such innovations will fail the test of time. new products should not be dependent upon an assumption of appreciating house prices, and incentives must be aligned to promote prudence in borrowing and lending. finally, the financial - accelerator dynamics the bank of canada has examined the related issue of appropriate time horizons for monetary policy when there

sheryl kennedy : real estate, mortgage markets, and monetary policy remarks by ms sheryl kennedy, deputy governor of the bank of canada, to the investment industry association of canada, banff, alberta, 23 june 2008. * * * good afternoon. it's great to be in banff – today especially. on this day in 1887, parliament enacted the rocky mountains park act, which established banff as canada's first national park. happy birthday, banff national park! i am delighted to be at this iiac conference. just as parks and conservation are vital for our, and our children's environmental and spiritual well - being, sound investment is vital for our long - term economic and financial well - being. for many canadians, one of the most important investments they'll make is the purchase of a house. and for you as financial market professionals, the links between the housing market and financial markets have important consequences. today, i'd like to speak about housing and how it interacts with the economy, financial markets, and monetary policy. over the past 10 years, the canadian housing market has exhibited a good deal of strength. demand, supply, and prices have increased [ chart : housing activity in canada : 1998 - 2008 ]. but while the canadian real estate market does not currently exhibit the generalized signs of excess we see in some other countries, 1 we cannot afford to be complacent. after a fairly substantial run - up, real house prices have declined in the united states, the united kingdom, and spain, and canadians would be wise to remember that house prices can fall as well as rise [ chart : changes in real house prices in the u. s., the u. k. and spain ]. it wasn't that long ago – in the late 1980s and early 1990s, to be exact – that canada experienced its own real estate boom and bust. it took a decade after that before we saw activity pick up and real prices increase [ chart : changes in real house prices in canada ]. more recently, of course, we have seen in this part of the country a strong housing market cycle. the current state and likely future evolution of the housing market in canada have implications for the economy, financial markets, and policy - makers. i will describe these implications later, but first i'd like to set the stage by discussing the role of housing in the canadian economy and some of the factors that drive housing activity and prices. housing