There is probably no agency or government department at the State or Federal level that has more effect on our daily lives than The Federal Reserve Bank which is responsible for setting Federal monetary policy.
Monetary policy is set by the Federal Reserve Bank in several ways:
- The Fed increases and decreases interest rates
- The Fed also increases or decreases the money supply
Currently the Chairman of the Federal Reserve Bank is Ben Bernanke and he oversees the Federal Open Market Committee which is the division of Federal Reserve Bank that sets monetary policy. Currently the Federal Reserve Bank’s monetary policy is focused on lowering interest rates and expanding the money supply.
A short explanation is in order here.
Lower Interest Rates
Lower interest rates are easy to understand as lower rates lead to additional buying power for products that normally require financing, such as cars and houses. Lower rates equate to lower monthly payments. When people have “additional” buying power due to lower rates they are empowered with added purchasing power which leads to a possible imbalance in the supply/demand ratio, which normally leads to an increase in prices, which is currently happening to the price of houses.
With interest rate at historically low levels, more people are able to qualify for real estate mortgages and are able to buy higher priced homoes than if interest rates were at higher levels. Also when interest rates are at such low levels potential buyers develop the attitude that “they don’t want to miss-out” on the low mortgage rates so even if they were not intending to purchase a home for a year or more in the future they often move up their buying plans to get in on the low rates. The effect of this psychological mindset contributes to additional supply/demand imbalance.
Expansion of Money Supply
The second way that the Federal Reserve Bank sets Monetary Policy is through the expansion and/or contraction of the money supply. Currently the policy is to expand the money supply by many of billions of dollars per month. This is often termed “printing money” and is accomplished by contracts the Federal Reserve Bank sets up with the United State Treasury Department through the buying and selling of bonds, where money is really created out of thin air. This monetary policy can lead to inflation as has happened many times in the past. The main reason that consumer prices have not currently increased is due to the continuing effects of the recession and the anemic economic recovery that the economy is experiencing.
In the near future interest rates will begin to rise from their historic lows and the demand for real estate will decrease which will put downward pressure on home prices. If money supply policy continues unabated (The Fed continues to pour billions into the economy), inflation could rear its ugly head which historically leads to higher real estate prices. When the two opposite forces are compared, the drop off in demand due to increased interest rates should more than offset the inflationary pressure on real estate prices.
Our conclusion is that while real estate prices are currently going up there appears to be a ceiling that will be determined on any increase in mortgage interest rates.
Caution is advised in over optimism about the current increase in real estate prices.