The Federal Reserve has plays a significant role in choosing the policyinstrument where there are two basic types of instruments: reserve aggregatesand short-term interest rates. The long-term interest rate is not directlyaffected by a Federal Reserve tool but it is linked to the actual goals.Besides that, Federal Reserve have set an interest rate target, known asinflation targeting to hold up future inflation. There are some criteria forchoosing policy instruments to monitor on future inflation and impact to theeconomy growth. The first criteria is observable and measurable, the short-terminterest rates will be observe instantly but is more accurate to measure costof borrowing by real interest rate.
The second criteria is controllability,which for both aggregates and interest rates have uncontrollable parts.Controllability not able to totally control on the monetary aggregates. It cancontrol on the short-term nominal interest rates but they cannot directlycontrol on the short-term real interest rates. The third criteria ispredictable effect on goals, the link between the interest rates and monetarypolicy goals is better than the link between monetary aggregates and inflation.Generally Federal Reserve is using short-term interest rates as their policyinstrument because it offer the best links to monetary goals but they are stilluse reserve aggregates. Besides that, Federal Reserve has using a fed watcherresponsibility to predicts when interest rates high and acquire funds to lowerthe interest rate. Meanwhile, the fed watcher predicts when interest rates lowand make loan at high interest rate to higher the interest rate.
Some of arguethat low interest rates had contributed to the housing bubble because FederalReserve had hold interest rates too low for too long time. During 2001-2002recession, the Federal Reserve dramatically lowered the interest rate from 6.5%to just 1% and this had led many banks for easy credit to make a lot of loans.But in 2006 Federal Reserve had increased the interest rate to 5.25% led thedemand on purchase house had decreased, the main reason is because burden ofincreased monthly payments for long-term mortgages. After the increasing on theinterest rate had lead the foreclosures increased because the mortgage borrowernot able to make monthly payment and dropping the housing price.
The formerchairman of Federal Reserve of the United States and also an Americaneconomist, Mr. Alan Greenspan had confessed one of the reason caused thehousing bubbles was declined long-term interest rates. Some people hadcriticized the Federal Reserve decreased the interest rates that inflated thehousing bubble. During 2000 and 2003, the interest rate on 30 years fixed-ratemortgages had dropped 2.5% and interest rate adjustable rate mortgages haddropped 3%. Decreased in mortgage interest rates had reduced the cost ofborrowing mortgage attracted many people wanted to borrow money to purchase ahouse and this had led the price of house keep increasing. Many people borrowedmoney from mortgage and securitized it turned into AAA-rated securities. Whenthe belief on house prices would not decreased started inaccurate because ofthe delinquency rate get higher and the price on mortgages–backed securitiesand house prices decreased promptly.
The cost of cleaning up after the housingbubble burst is expensive because it need take time to slow recovery. Based on the article of the former Federal Reserve Board Chairman, Mr.Alan Greenspan on 11 March 2009, he had mentioned that the Federal Reservedidn’t cause the housing bubble. The one of the reason led U.S. housing bubbleis the easy money policy, a money policy to increase the money supply by lower the interest rates and the purpose isa country’s central bank let new cash flows bring into the banking system.Another factor is lower interest rates on long-term or fixed-rate mortgages haddeveloped the speculative euphoria.
There is a highly significant correlationbetween house prices and mortgages rates. In 2004, mortgage rates had failed totighten as Federal Reserve expected and from the data showed the house mortgagerates gradually decoupled from the Federal Reserve monetary policy. For a longtime, U.
S. mortgage rates had not linked to U.S. short-term interest rates.
Butbetween 2000 and 2005, the long-term interest rates gradually lower because thecentral had planned to increase dynamic and export-led market competition. Alarge number of emerging market and highly growth in China led to an excessintended of savings advance to global. The regulators had underestimated thescale of the asset price bubble.
The real-estate capitalization rates declinedhad converged global and led to the global housing price bubble. The maindeveloped economy had declined to single digits while the long-term interestrates and house mortgage rates had driven by International Monetary Fund. The“Taylor Rule”, a useful and approximate to monetary policy but consistentlyunable to anticipate on the financial crises had implied that kept short-terminterest rates at the level would prevent the housing bubble. In the period of 2003to 2005, the Federal Reserve had inappropriate use of short-term rates andfailed to address the unusual structural developments in the global economy.Between 1996 and 2004, the US current account had deficit increased by $650billion and these deficit required to borrow large sums of money from abroad.Due to a highly demand funds from abroad, therefore they created various typesof financial assets and raising the prices of the assets while lowering theinterest rates. The housing bubble maybe caused by the broader global forcesand created complex financial products even through global market competitionand integration in goods and services have given great gains. Exclude the faulton monetary policy, we could attributes the housing bubble crisis to overseasregulators and the U.
S. credit rating agencies. The solutions for the housingbubble crisis is higher capital requirements, higher collateral requirementsand a wider prosecution of fraud.
Thenew regulations should more effectively bring a nation’s savings into mostproductive capital investments.