Fed rate increase raises worries of housing bubble
WASHINGTON – The Federal Reserve on Tuesday raised short-term interest rates a 10th straight time, but left the world wondering how high it would go, when it would stop and whether its go-slow policy has been effective.
Headed by chairman Alan Greenspan, the Fed is becoming a bigger target of criticism with its campaign of gradual interest-rate increases, which it launched last year as a way to keep the economy growing and inflation tame.
But a growing number of critics say the central bank’s policy of hiking interest rates could be too timid – a matter of too little, too late.
As a result, they say, a housing bubble has built up that could be troublesome to the economy if home prices should collapse. Peter Morici, a business professor at the University of Maryland, said Greenspan has been too lax by failing to criticize “extravagant” lending practices by financial institutions.
The sharp rise in housing prices has put affordable housing out of reach for many Americans, particularly in some especially hot markets like Washington and New York.
Oil and gasoline prices have surged, driven higher partly because the value of the dollar has fallen and partly because economic growth fed by lower interest rates has created more consumer demand for gas.
Almost as predictable as the tide, Fed policy-makers decided Tuesday to nudge its benchmark bank-lending rate to 3.5 percent, by the same quarter-percentage point it has increased this rate at its nine previous meetings. This federal funds rate, the rate banks charge one another for overnight loans, influences all other short-term interest rates.
This is the highest the fed funds rate has been in four years. In June 2004, the central bank began its policy of driving rock-bottom short-term interest rates to what it considers a more “neutral” or normal rate, thought to be in the 4 percent to 5 percent range. A neutral interest rate is supposed to keep the economy growing and inflation under control.
President Bush, meeting with his economic advisers in Crawford, Texas, sidestepped a reporter’s query about interest rates before the Fed acted.
“I trust the judgment of chairman Greenspan,” the president said. “He makes decisions based on facts, not politics.
“We’re more concerned about energy prices and health-care prices” than higher interest rates, Bush added. “These are the two areas that we see as having a greater effect on the future of economic growth.”
But short-term interest rates are near the point where they could have a negative impact on economic growth, economists said. Christopher Probyn, an economist at Boston’s State Street Bank, estimated the neutral interest rate sought by the Fed is probably 5 percent, meaning there could be six more rate hikes like the one announced Tuesday.
But Probyn said there is a danger that the central bank will overshoot this neutral mark as it raises interest rates to combat inflation. In previous business cycles, the central bank has overreacted in battling inflation and created economic slowdowns, even recessions.
Many economists believe the Fed’s failure to move faster with bigger interest-rate increases is responsible for a surge in housing prices. Nigel Gault, chief economist at Global Insight, a Boston consulting firm, said the central bank probably expected its policy would have forced mortgage rates higher than they have turned out to be.
Although short-term interest rates have gone up, long-term interest rates, such as those on mortgages and bonds, have remained low for a number of reasons, including the fact that foreign countries are pumping enormous amounts of capital into the United States.
Morici said the Fed’s control over monetary policy has been undermined by the flow of foreign capital from China in particular, which he said is amassing billions of dollars because its currency, the yuan, is undervalued against the dollar.
The Fed doesn’t directly control long-term interest rates, but in the past long-term rates have tended to rise with short-term rates, economists said.