INTEREST RATES AND HOUSING
August 17, 2005
Last week the Federal Reserve again raised the federal funds interest rate, which now stands at 3.5 percent. When the Fed began monetary tightening in June 2004, the rate was just 1 percent, says Bruce Bartlett, a senior fellow with the National Center for Policy Analysis.
Thus far, there is little evidence that the Fed's actions have had any effect either on financial markets or the real economy. Market interest rates, especially for mortgages, remain low and economic growth continues at a steady, if unspectacular, pace. Given the Fed's actions, economists would have expected interest rates to be higher and growth to be slower. The Fed calls the lack of impact a "conundrum."
As a consequence, some analysts are saying that the Fed will have to raise the fed funds rate higher than it originally planned:
- A majority of forecasters in the Wall Street Journal's latest survey expect it to hit 4.5 percent before the Fed stops.
- Economists at Goldman Sachs are predicting 5 percent.
The problem is that just because the Fed is raising rates gradually doesn't mean that the impact will be gradual. It could come quite abruptly. Think of a balloon. Whether you blow it up slowly or fast, at some point it is still going to burst. The same thing oftentimes occurs with monetary policy. It may appear that nothing is going on for a long time and then, suddenly, something dramatic happens to show that monetary policy is working as expected.
Another problem is that the Fed's policies always take time before they impact and these lags vary. So it's very difficult to know precisely when the impact will be felt, says Bartlett.
Source: Bruce Bartlett, "Interest Rates and Housing," National Center for Policy Analysis, August 17, 2005.
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