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Questions Remain on Housing Market, Economy

April 5, 2017

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Is the economy moving too fast or not fast enough?

The March 15 decision from the Federal Reserve to raise interest rates for the third time since before the 2008 financial crisis has largely been seen as a positive development, even if it could cause mortgages and other forms of debt to become slightly more expensive. More promising was the general consensus view of the U.S. economy’s trajectory over the next few years. Fed officials seemed to signal a willingness to continue to raise interest rates incrementally, potentially instituting two more rate hikes in 2017 alone. Since interest rates are increased to slow the rise of inflation, and inflation is generally tied to spending and growth projections, most take this decision as a sign that the U.S. economy is healthier than it’s been in some time.

“Economists aren’t sure if inflation will become a problem in the near future.”

But like so much in economics, there are two sides to this coin. As explained in analysis from Freddie Mac, experts disagree as to whether the economy is over- or under-performing as it relates to inflation.

On the one hand, inflation as measured by the Consumer Price Index is rising, almost at the rate of 2 percent per year which the Fed considers an optimal level. But with job growth and other indicators as strong as they are currently, some say inflation should actually be higher. Moreover, mortgage interest rates remain historically low as home values continue to rise.

By examining the relationship between inflation and the housing market, Freddie Mac’s analysis offers three different scenarios, each with a high, medium or low degree of likelihood (as judged by the current political and economic climate):

Most likely: Government approves stimulus through tax cuts and spending

A steady yet manageable rise in inflation leads to a continuation of low mortgage interest rates and just under 5 percent annual appreciation of home prices. This scenario is deemed most likely by Freddie Mac.

Somewhat likely: Government approves major tax cuts and federal spending hikes that exceed expectations

The second-most likely scenario is essentially the first projection on overdrive. With a strong grip on Congress, the U.S. could pass “expansionary fiscal policy [that] exceeds expectations.” This would include major tax cuts as well as more federal spending. The result would push total economic growth higher, but also boost mortgage interest rates, home prices and inflation. This could cause home sales to drop precipitously.

Least likely: Government forgoes stimulus and/or stimulus fails

The least-likely scenario is one where fiscal stimulus either fails in its objectives, or is never enacted. Home sales would rise as lower mortgage rates make it easier to enter the housing market, but real estate investors and financial institutions would suffer.

The latest actions by the Fed have broad implications on the U.S. housing market.

Is there room to grow?

The key question at the heart of this discussion is how close the U.S. economy in general is to its full growth potential. As Neil Irwin of The New York Times explained, answering that question requires first understanding what maximum growth even is. The Congressional Budget Office estimated that the country’s gross domestic product will improve to a 2.5 percent growth rate at the end of 2017. However, newly elected President Donald Trump has expressed a willingness to grow the economy at almost twice that rate.

Unlike with how an individual or even a business manages finances, though, high growth can be too much of a good thing. When GDP rises quickly, rapid inflation is often the result. To reach full growth potential, Irwin explained, the U.S. needs to focus on operating more efficiently. Using three different metrics, Irwin noted that the nation may not be reaching the same economic heights as it was in the mid-2000s. Unused manufacturing capacity, office vacancy and, most critically, the unemployment rate of working-age people, are all still higher than they were 10 years ago.

If the U.S. can put people back to work who stopped trying to even reenter the job market after the recession, it could see sustainable growth in the form of more affordable homes, appreciation of real estate and more. How we get to that point, though, is yet another matter entirely.

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