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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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