Juggling Dynamite

The San Fransisco Federal Reserve published its latest economic letter last week, entitled Does Monetary Policy Have Long-Run Effects? The conclusions are clear: loose monetary policy does not raise long-run economic potential while the eventual tightening of policy reduces economic output for a decade and beyond. We have entered the payback decade:

Analyzing cross-country data for a set of large national economies since 1900 suggests that tight monetary policy can reduce potential output even after a decade. By contrast, loose monetary policy does not appear to raise long-run potential. Such effects may be important for assessing the preferred stance of monetary policy.

… in response to a 1% increase in interest rates, output would be about 5% lower after 12 years than it would otherwise be. To provide some context for these numbers, consider some data for the United States. A 5% decline in the output trend caused by the monetary intervention relative to the pre-intervention trend would reduce an individual’s income by $3,000 in today’s dollars on average.

…If raising interest rates can have such costs in terms of the longer-run capacity of the economy, what about lowering rates: can a central bank boost the economy’s long-run potential with more accommodative monetary policy through lower interest rates?

Figure 2 (below) shows that this is not the case. When we separate our interest rate experiments into those that resulted in rate hikes versus those that resulted in lower interest rates, we see that there is no free lunch. That is, a central bank might not be able to undo the long-run effects on the economy’s potential by running the economy hot. The blue line shows that lower interest rates have mostly temporary effects that vanish after a few years, as traditional theories predict. However, the red line reinforces the results from Figure 1 that show an increase in interest rates casts a long shadow on the economy.

Good news: Big Wall Street Investors like Blackrock, Blackstone, Invitation Homes, and Progress Residential are no longer buying up the housing market. As the rental supply balloons, rents are starting to fall. The next leg of housing downturns typically see for-sale listings surge and prices fall. Nick Gerli explains well in his latest video segment.

Especially in cities like Charlotte, Atlanta, and Las Vegas, where investor purchases declined by over 60%. Investors are bailing on these markets because a combination of 1) higher interest rates, 2) higher vacancies, and 3) lower rents is making real estate investment a money-losing proposition.

The issue with Mortgage Rates is especially problematic. Because now the 30-year fixed mortgage rate of around 7% is way above the income yield (or cap rate) that investors get from their rental. So quite literally – real estate investors who buy today with debt are losing money on their property. And thus they’ve stopped buying.

But when will these big Wall Street real estate investors start selling? Because so far they’ve held onto their houses. And thus inventory on the US Housing Market is low. But I suspect eventually, as more houses sit vacant and the tax, insurance, and mortgage bills pile-up, more investors will be induced to sell. Especially in a market like Nashville, where the investor purchases are down over 50% in the last year and the inventory on the market has surged. Here is a direct video link.

Danielle was a guest with Jim Goddard on This Week in Money, talking about recent developments in the world economy and markets, starting at 10:25 on the playbar.