The Fed’s Decision Not to Change Interest Rates

March 17, 2010

The Federal Reserve’s Federal Open Market Committee voted this week to not change interest rates. Ted Gayer, senior fellow and Economic Studies co-director, explains that while the economy continues to strengthen, there is still a lot of economic uncertainty, which is why, he says, the Fed’s move wasn’t surprising.


“There are two things I would look for, for today. One is the Fed has been talking for many months now about keeping rates low for an extended period of time. I can’t remember the exact language they used, but they have been very careful to use it each time, basically reassuring everyone that it is going to be for a long time. I don’t think there is any movement now to raise rates, especially in the short-term, but there may be in the months to come as the economy shows some signs (albeit mixed) of strength, that they are at least going to forecast their future increases or how long this extended period is going to last. So I think everyone is going to be looking for signals there.

But the other issue, as you say, is signals on the housing market. They announced months ago that their very ambitious program to purchase mortgage-backed securities is to be phased out at the end of this month. So after purchasing $1.25 trillion worth of these securities it is going to end at the end of March. I think I would look for some signals about whether or not they still feel comfortable in that plan. My guess is that they do, but they are going to, I think, send signals either now or later that should mortgage rates jump as a result of this pulling out of the market, that they would be, at least, equipped to re-enter. From the look of mortgage rates right now that doesn’t look likely, but I think one of the advantages of monetary policy is that they can pivot quickly should the circumstances change.”

“I think the housing market is in a rather uncertain place right now. We still have fairly substantial excess inventories of homes, and we are working our way through it. So it is kind of a weird way to look at the bright side of the housing starts, but if housing starts are down that means we are eating through our excess inventories. I think it is important to back up and realize the problem we have here is we built too many homes. Until we work through that excess supply we are going to see an uncertain housing market.

The real issue for housing going forward – we have seen some stabilization these last six months – but the real issue is two-fold. On the demand-side we have some government programs, most notably from the Federal Reserve, kind of being phased out and that is going to suppress demand for housing. And on the supply-side, I think the real issue going forward is what is going to happen to all of these homes that are working through the foreclosure process? Will these home-owners be able to stay in their homes? Or will we actually see a big surge in foreclosures, and what we call short-sales, where essentially a lot of homes come onto the market? If we see that in the year to come, then we would see a big increase in supply and that could really harm prices (and actually cause some troubles for the housing market).”

“On the policy front, I think there have been three different policies to promote or to sustain the housing market. I would say the most substantial, arguably, is the mortgage-backed security purchase program by the Federal Reserve. Especially if you think what would happen without it, the mortgage finance market essentially evaporated after the financial crisis. They were there to support that market substantially. So mortgage rates have been, I would imagine, substantially lower as a result of this program which has boosted demand.

The other two programs – one is the first time home-buyer tax credit (which is now also an existing home-buyer tax credit). I would think that has done less. Certainly it has done something to support housing, although I think primarily what it has done is shift renters into buyers (by incentivizing renters to become buyers) which I don’t think gets to the underlying problem in the housing market.

The other policy that has affected the housing market – it is arguable how good this is – is the HAMP program (foreclosure prevention) and other related programs to forestall foreclosure. Really, the uncertain question here is whether or not this is leading to a reduction in supply of distressed homes by keeping people in their current mortgages, or whether or not it is just delaying the inevitable and just stretching out that process. Even there, one might be able to argue that that might not necessarily be a bad policy. By stretching out the pain (so to speak) that could be leading to more gradual adjustment in the housing market. I am of mixed mind about that. As I said, I think there is an underlying problem in the housing market with an excess of inventories, and I think we really just have to work our way through it. So programs that can help people stay in their homes – I understand the desire behind that. Given the fundamentals I think there is only so much you can do along those lines.”