Bloomberg News

Housing Weakness Impedes Monetary Policy, Feroli, Harris Say

February 27, 2012

Feb. 24 (Bloomberg) -- Weakness in housing is a “main impediment” to a stronger economic recovery and to the effectiveness of monetary policy, according to economists at JPMorgan Chase & Co. and Bank of America Corp.

“Problems related to housing introduce significant challenges to monetary policy-making,” according to a paper presented today at a forum in New York. The paper recommends policies that directly tackle housing issues, such as assisting in refinancing underwater mortgages and helping turn foreclosed properties into rentals.

“Few doubt that housing weakens the effectiveness of monetary policy and represents a drag on economic growth going forward,” wrote Michael Feroli, chief U.S. economist at JPMorgan, and Ethan Harris, co-head of global economic research at Bank of America. “The difficulty lies in quantifying how large these effects are.”

The 47-page paper shows that in states that dodged the housing bust, such as Texas and the Dakotas, gauges of real economic activity have recovered rapidly compared with the rest of the country. Since 2006, home renovations in such states are 19 percent higher, new residential investment is 5 percent higher and auto sales are 10 percent higher, providing estimates of what the rest of the country is missing.

Record Stimulus

Record monetary stimulus from Fed Chairman Ben S. Bernanke, including more than three years of zero interest rates and $2.3 trillion of asset purchases, has failed to return unemployment near the levels that prevailed in recent decades. The collapse in housing and a malfunctioning mortgage market may be the key reason, according to Feroli and Harris, whose paper was cowritten by Amir Sufi at the University of Chicago Booth School of Business and Kenneth West at the University of Wisconsin.

“The period of freefall in the housing market ended two years ago, but the housing market is best described as being in a slow-bleed equilibrium,” the authors write.

The damage the housing collapse caused to state and local government financing and to housing-related services remains “underappreciated” by business economists, they write.

The paper was presented today at the 2012 U.S. Monetary Policy Forum in New York to an audience of policy makers including New York Fed President William Dudley, St. Louis Fed President James Bullard, Philadelphia’s Charles Plosser and San Francisco’s John Williams.

‘Market Frictions’

“It is crucial that policy makers think carefully about the market frictions that justify a policy response,” Feroli and coauthors wrote. “A mistake would be to adopt policies that seek to artificially boost house prices and residential investment going forward.”

Bernanke sent a Fed study on the U.S. housing market to Congress last month. In a cover letter, he said “restoring the health of the housing market is a necessary part of a broader strategy for economic recovery.”

The Fed chairman said policies that would help resolve the slumping housing market could include programs to ease the conversion of foreclosed properties to rental properties. Avoiding foreclosure through “a broad menu” of loan modifications could also help minimize foreclosures, he said.

“We also believe that policies must recognize the possibility that a dramatic overinvestment in housing driven by unsustainable house price growth during the boom will not be magically cured,” they wrote. “In this sense, policies should identify specific market frictions and target those frictions, rather than attempt to boost house prices artificially.”

Fed officials are debating whether to launch a new program to purchase additional mortgage-backed securities, a decision that San Francisco’s Williams said is a “close call.”

‘Policy Accommodation’

“We may still need to provide more policy accommodation if the economy loses momentum or inflation remains well below 2 percent,” Williams said in a Feb. 8 speech in San Ramon, California. “Should that occur, restarting our program of purchasing mortgage-backed securities would likely be the best way to provide a boost to the economy.”

Purchases of new homes in the U.S. exceeded forecasts in January after climbing a month earlier to a one-year high, more evidence the housing market is stabilizing. Sales were 321,000 at an annual pace, beating the median estimate of 77 economists surveyed by Bloomberg News who called for a rise to 315,000.

Sales, tabulated when contracts are signed, fell 0.9 percent to a 321,000 annual pace from a 324,000 rate in December that was stronger than previously reported, figures from the Commerce Department showed today in Washington. The median estimate of 77 economists surveyed by Bloomberg News called for a rise to 315,000. The number of homes for sale dropped to a record low.

Confidence among U.S. homebuilders rose in February to the highest level since May 2007 as sales and buyer traffic improved, according to the National Association of Home Builders/Wells Fargo sentiment gauge.

--Editors: Gail DeGeorge, Christopher Wellisz

To contact the reporters on this story: Joshua Zumbrun in New York at jzumbrun@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net


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