May 19, 2024

fighting victory

Today’s Events in Historical Perspective                                                                     
America’s Longest-Running Column Founded 1932
Stop fighting victory
By Douglas Cohn and Eleanor Clift         
          WASHINGTON — The war against inflation has been won. Apparently, the Federal Reserve did not get the memo or at least the memo distinguishing between short- and long-term interest rates. The 12-member Federal Open Market Committee (FOMC) of the Federal Reserve sets the discount rate – the interest rate the Fed charges commercial banks for loans – its primary tool to bring down inflation by inhibiting demand. As such, it is the rate most other rates key off for everything from cars to houses.
          But there’s the rub. The demand for car loans and the demand for home loans are separated by the length of the loans, the total interest paid on a five- or seven-year car loan being a fraction of the interest paid on a 30-year mortgage.
The payment (rounded to the nearest dollar) for a six-year $40,000 car loan at 7 percent is $682 per month and $721 per month at 9 percent, whereas the payment for a $600,000 home mortgage is $2,530 per month at 3 percent, $3,221 a month at 5 percent, or $3,992 per month at 7 percent.
          Clearly, there is a significant distinction between a six-year short term loan and a 30-year long term loan. The impact of the Fed’s rate increases or cuts barely impacts the short-term loan but significantly impacts the long-term loan to the point that home buyers – especially first-time home buyers – are dissuaded or unable to get into the housing market.
          Interest rates do impact large short-term commercial loans by increasing the cost of products and services, which counter-intuitively thwarts the Fed goal of decreasing inflation. This does work because although the supply side costs increase, the demand side (consumption) decreases forcing the supply side to cut margins, increase productivity, or find cost-cutting savings.
          This does not carry over to a housing market that heavily relies upon the buying and selling of existing homes. A homeowner is not a business. A homeowner can only sell and move but cannot maintain the same standard of living by selling a home with a 3 percent mortgage and buying a home with a 7 percent mortgage unless there has been a substantial increase in income. As a result, the high Fed interest rates have frozen the housing market.
          So, it is no wonder that the stock market reacted negatively when the Federal Reserve Bank of Atlanta President Raphael Bostic made news telling reporters there might be only one rate cut this year or when Federal Reserve Bank of Minneapolis President Neel Kashkari suggested that no rate cuts may be in order. However, these well-known interest-rate hawks were countered by Fed Chairman Jerome Powell who has repeatedly adhered to his expectation of three quarter-point point cuts this year.
          What Powell and company have not addressed is the short-term, long-term conundrum. They have eased up on their 2 percent inflation target, now saying that moving in that direction is sufficient. In fact, the inflation war has already been won with some indicators already below 3 percent. The refusal to acknowledge this has led to a problematic real estate sector, which only an easing of mortgage rates is going to change. This is why it is time for the Fed to declare victory in the inflation war and lower the discount rate, not gradually and later in the year, but significantly and now.
          Eleanor Clift’s latest book Selecting a President, and Douglas Cohn’s latest books The President’s First Year: The Only School for Presidents Is the Presidency and World War 4: Nine Scenarios (endorsed by seven flag officers).
          Twitter:  @douglas_cohn
          © 2024 U.S. News Syndicate, Inc.
          Distributed by U.S. News Syndicate, Inc.

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