Matt Yglesias notes the housing bubble in Canada and then asks what the Canadian government could do about the bubble. His point is that it would be enormously unpopular if the government deliberately took steps to burst the bubble.

This is of course true and it is one reason why the government should have acted years earlier to prevent the bubble from getting as large as it did. However there is another actor that doesn't appear in Matt's story, the Bank of Canada. The official story on central banks is that they are supposed to be independent so that they can do what is best for the economy without fear of the immediate political repercussions.

As a practical matter, central banks tend not to be independent of political influence, especially from the financial sector. However it is reasonable to ask why the central bank is not doing what it is supposed to do. Suppose the Bank of Canada announced a 1 percentage point increase in the overnight money rate and that it would continue to increase interest rates until house prices fell by 30 percent, or whatever amount it considered appropriate.

It is difficult to believe that this policy would not quickly deflate the bubble. This may not be pretty (if the bank had been awake it would have done this 5 years ago), but it would be better than letting the bubble just continue to grow. And what is the Bank doing that is more important, targeting 2.0 percent inflation?

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