Economists at the San Francisco Fed earlier this year quantified how responsive mortgage lending and home prices are to interest rates and found that the federal funds rate would have needed to increase by about 8 percentage points in 2002 to keep house prices on trend.
“Preemptive interest rate policy would have been extraordinarily tight in 2002 then would have gradually abated to around the level eventually reached in June 2006,” the economists wrote. “By our calculations, such a large increase in interest rates would have depressed output more than the Great Recession did, roughly speaking.”
Even so, the Fed has learned “sobering message” that it’s hard to contain an existing crisis after the housing crash, said Stephen Oliner, a scholar at the American Enterprise Institute and former Fed Board research director. That’s given them a new focus on preemptive policy, even it only helps at the margin, he said.
“They can nudge things, and I think that’s really about all,” Oliner said, adding that policy makers are “acutely worried” about fueling asset bubbles with easy policy. “It’s going to be something you hear about from more Fed officials.”