For at least the last three years, people have been predicting a Canadian housing crash and ensuing recession. Yet the economy continues chugging along and home prices are still going up.

However, “house prices can’t climb faster than incomes forever,” as was duly noted by CIBC chief economist Avery Shenfeld.

Whether plummeting house prices will be the trigger for the next recession or not, it is likely to be more severe, and take longer to recover from, due to today’s lofty real estate values.

“Today’s high house prices do pose a material risk that, when it comes, the next recession would be longer and deeper than otherwise,” Shenfeld wrote in a recent note entitled Would We Fear or Cheer a House Price Correction, co-authored by economists Andrew Grantham and Nick Exarhos.

One of the key reasons, the authors argue, is that the Bank of Canada’s ability to raise rates to contain growth and inflation is limited primarily by today’s larger average mortgage principals needed to pay for expensive housing.

“A two per cent rise in mortgage rates would be fairly gentle by past tightening cycles, but would raise monthly payments by roughly 25 per cent on a conventional five-year mortgage,” Shenfeld wrote, adding that insured mortgages have a little more of a cushion built in to help keep borrowers solvent.

“It’s going to take a lot less hiking to keep a lid on growth and inflation in the next few years, leaving a lot less room for conventional rate cuts when a recession eventually hits,” he said, adding that negative rates and QE (quantitative easing) “haven’t proven to be as effective as substitutes.”

The authors also touched on several potential triggers for a home price correction that could lead to a recession:

BOC Rate Hikes

“It’s a near truism that a steep enough climb in interest rates would send prices south,” the report read. “The Bank of Canada is only going to be raising interest rates because the economy is doing well. So if house prices were falling in that environment, as might be the case, it would be circular to say that the economy would be in ruins.”

Mortgage Quality

Poor mortgage origination standards was a key trigger for the U.S. housing crisis, but seems to be an unlikely cause for a Canadian housing crisis. One of the biggest clues is mortgage arrears rates. Prior to the U.S. financial crisis, 90-date mortgage delinquency rates soared to 8 per cent. In Canada, the arrears rate has been flat at around 0.28% for the last few years.

Gravity Trigger

The report found that major house price retreats with no interest rate or recession trigger have no major precedent, neither in Canada nor abroad. It referenced a 15% year-over-year price decline in Vancouver in 2012, but noted it was short-lived and that GDP growth was little affected.

So what’s the solution? How can this scenario be avoided?

The authors said measures to stimulate increased construction today, to increase inventory and dampen price and rent inflation, could help soften the impacts of the next recession.

“Not waiting too long to begin nudging rates higher would also be an ingredient in the right policy mix,” they wrote.