Its latest policy to keep interest rates near zero through mid-2013 could backfire and prevent home sales instead of encouraging them
Basic economic theory says that when mortgage interest rates are low, consumers should feel more encouraged to buy a home. But right now, that intuitive theory might not hold. Kathleen Madigan at Real Time Economics proposes that the Federal Reserve's latest proclamation -- that short-term interest rates would be kept near zero through mid-2013 -- might discourage home buying. Could this be possible?
When Certainty Can Hurt
This might seem like a backwards idea. To be sure, the last thing that the Fed would aim for is to make the housing market worse off. So why would it allow one of its policies to keep home sales artificially low? This might be an unfortunate and unintended consequence of its desire to calm the broader market.
The logic works here because home prices are declining. Nobody is sure how far they might fall or when they'll finally hit bottom. But we can feel fairly confident that prices aren't there yet. And what do we now know? Interest rates will be low for another two years. So why hurry to buy a home now?
Savvy potential home buyers who can wait the market out now have a good reason to do so. They don't have to worry about interest rates rising before the market bottoms. Instead, they can wait for the market to continue to decline. If it appears to bottom out in the next two years, then they can step in and finally buy at that time. But if prices keep declining over this period, then they'll be smart to buy in the first half of 2013, just before interest rates might begin rising. In the near-term, you might be better off waiting.