Written Assignment UNIT 2 authors position on housing bubble PDF

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housing bubble and factors that affect housing bubble...

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WRITTEN ASSIGNMENT UNIT 2 Introduction During the period 2001-2003 monetary Policy in the US was the loosest it had been since the 1950s. In the same period the share of residential investment in the GDP soared at an unknown rate, producing a bubble and heighten price that would both in the end collapse in 2006. Many economists have recommended that these two development were closely related. This paper will appraise opinion posed by the author of monetary policy and Housing Bubble discussing several relative issues in the process. The Author’s position- monetary policy by the US Federal Reserve contributed to the housing bubble, they however, provide evidence to show that the monetary policy was indeed well aligned to set goals and thus was not primary contributor even if it did vaguely in other ways. Taylor Rule- is a formula that can be used to produce or guide how central banks should alter interest rate due to change in the economy. This rule recommended that the Federal Reserve should increase rate when inflation or GDP growth level are higher than desire. The rule is represented by a formula R=P+0.5Y+0.5(p-2)+2 where R is nominal Fed Fund rates P is the rate of inflation and Y is the percentage deviation between real GDP and long term trend in GPD. Loose Versus tight monetary policy- when monetary policy lower interest rate borrowing is stimulated, this is called loose monetary policy while tight or contractionary monetary policy seek to slow economic growth to head off inflation . It can be said that the policy that was implied at the time was loose policy which embolden borrowing which would in return encourage persons to take up more debts, heighten spending in the housing sector by driving up the price and creating a bubble. Rise of cheap and available credit stimulated housing demand – beside the low interest rate for the period held for such a long time, credit becomes affordable and obtainable stimulating several sector of

the economy including the housing sectors. With such availability there are more buyers entering the market, thus increasing demand which in turn drive up the price. Low rates accompanied increase in demand for housing - One of the major factor influencing housing demand on interest rate is the lower the rate or borrowing cost the more persons are willing to take on debts because they can afford to that on the same monthly expense. The demand for housing will increase as more buyers enter the market, this will cause housing price to drive up, this seem relative to the period discussed. Evidence that monetary policy played a role by other research- for example shillers (2007) have presented a series of case studies in which he outline psychological as some of the ways that monetary policy sparked the boom, in his thinking he postulated the perception that housing price where likely to rise rapidly and not likely fall. This created a positive feedback loop which sustain the demand and increasing price. He back up his thinking with examples related to historical housing market pattern in ancient market where low interest rate in the past created the feeling that price will continue to rise. Evidence that monetary policy played a role by the timing of house boom- timing on the housing boom according to Dokko et al. (2009) was that nominal house price growth began to pick up in the late 1990s. Consequently shiller (2007) suggested that the boom began in 1998, this timing clearly predates the accommodative monetary policy following the 2001 recession. However, the pace of house price increase notably after 2002 and much of the overvaluation in the house price appear to have occurred after 2002. As with the data on residential investment the timing of these events suggest that it may be possible to draw a causal link between the setting of monetary policy and the strength of housing. Housing price improve rapidly over the past decade. References http://www.resources/archived/site/textbooks/money and banking.pdf http://www.federalreserve.gov/pubs/feds/2009/200949/200949pap.pdf...