"housing... is the principal channel for monetary policy"

[cthulu2016]

This is fascinating for a lot of reasons. The chart tells a certain story quite succinctly.



The Fed started raising rates circa 2004 to cool-down the economy. Normal so far... the housing top was induced to regulate inflation, as most modern boom-tops are. So the Fed raises rates (which were artificially low because of 9/11).

Then they start to realize that the housing market cannot be cooled off without bringing down the whole house of cards because, for the first time, we have half the financial system pegged to the housing market through derivatives. Too late!

And because we slew the inflation dragon in the early 1980s (to the eternal detriment of all but the super-rich and banks) rates were too low to have enough room to cut before hitting zero. It's like parachuting from a plane flying at 500 feet altitude.

Take-away insight from the Krugman piece below: "housing... is the principal channel for monetary policy" meaning that housing is a big part of GDP and is very interest-rate sensitive, so when the Fed shapes the economy with interest rates the rise and fall of construction is the biggest way those rate changes enter the real economy -- employment, materials, appliances, etc. Housing used to be a slow, cyclical matter of building houses and selling them and it was a good channel. But derivatives made it an explosive channel. Like the bus is SPEED, it was rigged with enough deritvative bombs that if it slowed down it would explode.

An area for study: The 1990s stock market bubble seemed unusually interest-rate sensitive to me, not for what rates said about economic growth, but because much of the internet bubble was financed on margin and all formulas of the relative value of assets (like stocks) rely in the price of money. And Greenspan used the Fed funds rate as a means of steering the stock market because his one big career success was the quick rebound from the crash of 1987. He always cut rates in response to the stock market going south and kept the intente bubble going a extra year by intervening in response to the 1998 Asian hedge-fund problem. I felt that the 1990s stock market was quite "exotic" and derivative-filled, but I'm no expert.

...As I said then, there’s a definite change in the character of recessions after the mid-1980s. Before then, recessions were basically brought on by the Fed, which raised interest rates sharply to curb inflation, causing a slump in housing. When the Fed decided that we had suffered enough, it let rates fall again, and there was a surge from pent-up housing demand. Morning in America!

Since then, however, inflation has been well under control, and booms have died of old age — or more precisely, they have died because of overbuilding and an excessive level of debt. The Fed is then in the position of trying to goose housing (which is the principal channel for monetary policy) even though housing may already be overbuilt (which was the point I was making, sarcastically, when I said long ago that the Fed has to create a housing bubble), and it is cutting rates from an initial level which isn’t that high. So the odds of running up against the zero lower bound are high, and recovery can be a long time in coming.

You can see what I’m talking about here:



The early-80s slump was brought on by a huge rise in the Fed funds rate, which left lots of room for cuts, and was driven by a deep slump in housing, which meant that there was lots of pent-up demand when rates fell again. The 2007-? slump was brought on by the bursting of a housing and debt bubble, and left the Fed largely pushing on a string.

http://krugman.blogs.nytimes.com/2012/01/27/postmodern-business-cycles/

[cthulu2016]

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