Economist's Commentary: September 16, 2008
The FOMC Stands Pat
By Danielle Hale, Research Economist
This afternoon the Federal Open Market Committee (FOMC) decided not to respond to market expectations of an additional cut on the Federal Funds rate. Ben Bernanke and his colleagues held the rate steady at 2.0%. The market odds on a rate cut were better than 50 percent yesterday and increased throughout the day until the Fed's announcement at 2:00p.m. This is not the first time the market has missed. In March, it expected a larger cut than the Fed ultimately provided. As was also, the case in March, markets quickly fell following the announcement, and then recovered. The initial disappointment from the market comes from those reacting to the short run. The upturn later in the day comes as those focused on the long run prevail. In this commentary, we will examine why the Fed did not cut rates and why that may be a good thing for Realtors® and consumers.
Why didn't the Fed respond?
Today's CPI report showed that inflation is easing in large part due to declining energy prices. This retreat of inflation is welcome news and is expected to continue throughout 2009. However, according to the Fed's assessment in its statement released after the meeting, risks remain. The Fed also acknowledged the turmoil of the weekend and signs of weakening economic health, but noted that monetary policy has already eased significantly, in part to deal with a forecast slowdown. Because the Fed is already in an accommodative position-the Fed funds rate is low and the real rate is even lower-it decided that further easing was not necessary. Furthermore, the Fed may have wanted to avoid responding to this weekend's crisis with monetary policy-a very blunt tool; to the extent that short run crises require government response, a precision instrument is preferred.
How does the Fed's move keep mortgage rates low?
The FOMC's stand today demonstrates that it is keeping its eye on weakness in the economy but is not willing to be a tool of the markets. As inflation pressures begin to abate, the FOMC will want to continue the course to convince the market that low-inflation is still the goal and that the Fed will finish the job of returning the economy to a low-inflation course. A cut in the Fed funds rate today might have been counterproductive because it could have disrupted the return to low inflation. When inflation gets out of control, it leads to higher rates on mortgages and other long-term loans. Inflation also weakens the value of the dollar. While a weak dollar is great news for American exporters, it makes imports, including oil much more expensive.
A Word About Oil
In fact, oil prices have retreated to below $100 for the first time in half a year. The decline in oil prices stems from the strengthening dollar and from weakening global demand. As you may have noticed, retail gas prices have not yet followed suit. The reason is twofold. First, changes in retail gas prices always lag changes in oil prices. Second, Hurricanes Ike and Gustav may not have caused much structural damage to oil refineries along the Gulf Coast, but they stopped work as they approached, and refining is still hampered by a lack of power resulting from the storms. The disruption of refining in an area that produces a significant chunk of the nation's refined petroleum products means the lag between changes in the price of oil and of gasoline may be even longer than usual. However, declines in the price of oil will eventually lead to lower retail gas prices-good news for Realtors® and consumers.
This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >
NAR members, learn how you can add this commentary to your Web site, blog, or newsletter. Read more >
Comments? Questions? E-mail NAR Research.
