Jim Hamilton has some interesting thoughts on the housing market and monetary policy. I found the last paragraph in his comments to the Fed conference at Jackson Hole to be particularly interesting.
He posits that to the extent that institutional changes are a response to interest rates, monetary policy will have longer impacts than otherwise. (Emphasis added below).
I don’t think that the institutional changes that we have seen recently are due only to interest rate changes, (although low interest rates probably played a part), but do agree that these changes might lead to longer impacts of rate changes. Indeed, the impact of rate changes (such as the increase a few years ago), could in fact accelerate over time, not diminish.
Finally, in closing, suppose that I’m wrong about all of this. Suppose that the developments I’ve been talking about– the appearence of loan originators in every strip mall, anxious to lend to anyone, and other parties just as anxious to buy those loans up– suppose that it is all a response to the traditional monetary instrument, the manipulation of the short-term interest rate. After all, a 1% short-term rate, 6% 30-year mortgage rate, and 13% house price appreciation, such as we saw in 2004, is plenty of incentive to borrow and repay. I used to believe that this was sufficient to account for all that we were seeing, and many of you perhaps still think that way. But if it were the case that all these institutional changes are just a response to interest rates, it means that the lags in the monetary transmission process are substantially longer than many of us had supposed. If people were still buying houses in 2006 as a result of institutions that sprung up from the conditions in 2004,it means that, if we thought in 2004 that overstimulation could easily be corrected by bringing rates back up, then we would have been wrong. And likewise, suppose you believe that the pain we’re seeing now, and may continue to see for a matter of years, until the new loan originators all go out of business, and recent buyers are forced out of their homes, is simply a response to a monetary tightening that ended a year ago. If so, then if we think today that, if things get really bad, we can always fix things by rapidly bringing interest rates back down– well, then, once again, we’d be wrong.