Tag Archives: Monetary Policy

Monetary Policy Isn’t the Channel through which You Want to Conduct Housing Policy

suburb housing

Robert Shiller has a column out (July 13) in The New York Times arguing against our longstanding national policy of incentivizing homeownership through direct and indirect subsidies. I’m very much of the persuasion that the benefits of homeownership that advocates have proclaimed, such as “planning, discipline, permanency and community spirit”, are outweighed by the costs of policies we’ve enacted to encourage it. So I agree with roughly 90% of what he has to say, especially with regards to getting rid of the mortgage interest deduction.

Unfortunately, continuing the troubling trend of reaching for policy ends with monetary policy other than full employment and moderate inflation, Shiller includes the Federal Reserve’s programs of quantitative easing (QE) among a list of programs and arrangements he is critical of.

These three rounds of QE that the Fed has implemented since the onset of the financial crisis operate under the theory that purchasing long-term bonds and mortgage-backed securities reduces long-term interest rates and spurs business investment. That’s a correct theory, and evidence of it being correct, while sadly underwhelming in the context of 7.6% unemployment and 1.2% inflation (core PCE), can be seen in interest rates on a myriad of long-term bonds. Moreover, as the Fed has begun formally discussing the conclusion of QE3 at recent FOMC meetings, market reactions have shown that investors are very susceptible to these bond buying programs.

10 year UST june 19

More generally speaking, and perhaps more intuitively from a consumer point of view, accommodative monetary policy boosts spending on durable goods that are dependent on consumer credit—cars and houses, etc. Reducing interest rates means that these items become more affordable, purchases of these goods increase, as does employment along their supply chains.

Along that line, ending the accommodative monetary policy at the Fed, QE, for the sake of stopping people from buying houses is insane. Again, unemployment is high and inflation is low. Effectively ending what meager recovery we’re having for the sake of traditionally non-monetary policy related objectives is an extremely bad proposal. It’s certainly the case that tighter money will diminish our collective ability to buy houses and stop another housing bubble from forming. That’s because tight money has the curious effect of reducing aggregate demand, reducing consumer spending, reducing investment, and increasing unemployment. Namely, it causes recessions.

While the risks and consequences of eventual knock on effects stemming from QE seem much more subdued than what many people such as Shiller have been saying, they are a possibility. But raising economy wide borrowing costs, eroding expectations of future growth, and pumping up the value of the dollar and consequently hurting our national export position so that people buy fewer houses is not something central bankers should be considering at a time of 7.6% unemployment and 1.2% inflation. And it’s not something that smart, Yale economists should be promoting.

Yet they are doing just that. It’s nuts.

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All Quiet on the Monetary Front

From the FOMC’s latest statement:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects moderate economic growth over coming quarters and consequently anticipates that the unemployment rate will decline gradually toward levels that the Committee judges to be consistent with its dual mandate. Strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook. The recent increase in oil and gasoline prices will push up inflation temporarily, but the Committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate.

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September. […]

Arguments regarding credibility and how difficult it is to earn in the world of central banking are often brandished about. Central bankers often imply that it’s the most dear and precious thing, and that it should not be squandered at any cost. The Federal Reserve has a lot of said credibility insofar as they are really good at fighting inflation. But that’s where the problem presents itself: that inflation fighting credibility comes at the cost of unemployment fighting credibility (it doesn’t have to, and there are examples of this, but that’s been the popular policy stance in the U.S. and Europe).

Many observers expected a more hawkish stance from the Fed following the positive news of the past few months; that qualifies as bad central banking to me and displays a lack of the appropriate kind of credibility. If they’re going to make explicit remarks such as keeping rates near zero through 2014, which I think they should continue to do, they shouldn’t find it acceptable that people second-guess them. Especially now, when expectations are the primary policy tool! I would find it mighty troubling that an unambiguous and neutral statement–by the Fed’s standards–was interpreted to be good news simply because the bad decisions that were expected didn’t materialize.

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