Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Thursday, November 17, 2005

Housing Prices:
Slow-Down or Implosion?

I have been suggesting for five or six months (see here and here) that

  • if the US housing market is over-heated,
  • and if housing prices are about to decline in some sense, then
  • we are more likely to see a slow-down in their rate of increase, and
  • possibly a decline in housing prices in some markets, but not
  • a big, flat-out bubble bursting.

Recently, Buttonwood, from The Economist, came to the party, albeit somewhat after others arrived, and with a different outlook.

Buttonwood ... is struck by how precarious America’s housing market is beginning to feel. It has been powering along mightily for the past four years on super-low interest rates and ever-higher house prices. Homeowners have borrowed against their paper wealth and spent it, fuelling economic growth. But none of that now looks likely to continue at remotely the same pace.
After much interesting discussion with which I agree, Buttonwood concludes,

In any event, the housing market reacts to monetary tightening after a lag of one to two years, it seems, so the temptation will be to overshoot. In which case the Fedsters will bring down house prices and the economy itself not with a whimper but a bang.
Whether you agree with Buttonwood or with me, one thing is clear: Ben Bernanke has his work cut out for himself. On one hand he doesn't want to over-stimulate the economy to offset the problems that will likely arise as the housing market cools off; on the other hand, he will not want the lack of stimulation to lead to a recession. From the NYTimes (reg. req'd):
"The contrast between the 1970's and today is very marked," Mr. Bernanke said. "Back then, we had high inflation expectations." He added that the Fed might have waited too long and then overreacted to higher oil prices, helping push the economy into recession.

Today, by contrast, "inflationary expectations remain well anchored" and the Fed could respond gently as long as those expectations remained low, he said.

Mr. Bernanke did not imply that he would stop the Fed's policy of gradually raising short-term interest rates from their low point last year. The Fed has raised overnight rates on loans between banks 12 times since June 2004, to 4 percent from 1 percent, and Mr. Bernanke said nothing to dissuade investors from their view that he would probably nudge rates slightly higher at least once or twice in his first few months in office.

For more on the difficulties facing Bernanke, see Tyler Cowen's piece at Marginal Revolution
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