The Federal Reserve has plays a significant role in choosing the policy
instrument where there are two basic types of instruments: reserve aggregates
and short-term interest rates. The long-term interest rate is not directly
affected by a Federal Reserve tool but it is linked to the actual goals.
Besides that, Federal Reserve have set an interest rate target, known as
inflation targeting to hold up future inflation. There are some criteria for
choosing policy instruments to monitor on future inflation and impact to the
economy growth. The first criteria is observable and measurable, the short-term
interest rates will be observe instantly but is more accurate to measure cost
of 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 can
control on the short-term nominal interest rates but they cannot directly
control on the short-term real interest rates. The third criteria is
predictable effect on goals, the link between the interest rates and monetary
policy goals is better than the link between monetary aggregates and inflation.
Generally Federal Reserve is using short-term interest rates as their policy
instrument because it offer the best links to monetary goals but they are still
use reserve aggregates. Besides that, Federal Reserve has using a fed watcher
responsibility to predicts when interest rates high and acquire funds to lower
the interest rate. Meanwhile, the fed watcher predicts when interest rates low
and make loan at high interest rate to higher the interest rate. Some of argue
that low interest rates had contributed to the housing bubble because Federal
Reserve had hold interest rates too low for too long time. During 2001-2002
recession, 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 the
demand on purchase house had decreased, the main reason is because burden of
increased monthly payments for long-term mortgages. After the increasing on the
interest rate had lead the foreclosures increased because the mortgage borrower
not able to make monthly payment and dropping the housing price. The former
chairman of Federal Reserve of the United States and also an American
economist, Mr. Alan Greenspan had confessed one of the reason caused the
housing bubbles was declined long-term interest rates. Some people had
criticized the Federal Reserve decreased the interest rates that inflated the
housing bubble. During 2000 and 2003, the interest rate on 30 years fixed-rate
mortgages had dropped 2.5% and interest rate adjustable rate mortgages had
dropped 3%. Decreased in mortgage interest rates had reduced the cost of
borrowing mortgage attracted many people wanted to borrow money to purchase a
house and this had led the price of house keep increasing. Many people borrowed
money from mortgage and securitized it turned into AAA-rated securities. When
the belief on house prices would not decreased started inaccurate because of
the delinquency rate get higher and the price on mortgages–backed securities
and house prices decreased promptly. The cost of cleaning up after the housing
bubble 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 Reserve
didn’t cause the housing bubble. The one of the reason led U.S. housing bubble
is the easy money policy, a money policy to
increase the money supply by lower the interest rates and the purpose is
a 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 had
developed the speculative euphoria. There is a highly significant correlation
between house prices and mortgages rates. In 2004, mortgage rates had failed to
tighten as Federal Reserve expected and from the data showed the house mortgage
rates gradually decoupled from the Federal Reserve monetary policy. For a long
time, U.S. mortgage rates had not linked to U.S. short-term interest rates. But
between 2000 and 2005, the long-term interest rates gradually lower because the
central had planned to increase dynamic and export-led market competition. A
large number of emerging market and highly growth in China led to an excess
intended of savings advance to global. The regulators had underestimated the
scale of the asset price bubble. The real-estate capitalization rates declined
had converged global and led to the global housing price bubble. The main
developed economy had declined to single digits while the long-term interest
rates and house mortgage rates had driven by International Monetary Fund. The
“Taylor Rule”, a useful and approximate to monetary policy but consistently
unable to anticipate on the financial crises had implied that kept short-term
interest rates at the level would prevent the housing bubble. In the period of 2003
to 2005, the Federal Reserve had inappropriate use of short-term rates and
failed to address the unusual structural developments in the global economy.
Between 1996 and 2004, the US current account had deficit increased by $650
billion and these deficit required to borrow large sums of money from abroad.
Due to a highly demand funds from abroad, therefore they created various types
of financial assets and raising the prices of the assets while lowering the
interest rates. The housing bubble maybe caused by the broader global forces
and created complex financial products even through global market competition
and integration in goods and services have given great gains. Exclude the fault
on monetary policy, we could attributes the housing bubble crisis to overseas
regulators and the U.S. credit rating agencies. The solutions for the housing
bubble crisis is higher capital requirements, higher collateral requirements
and a wider prosecution of fraud. The
new regulations should more effectively bring a nation’s savings into most
productive capital investments.