Raising interest rates is an effective way to cool off a housing market that is too hot, but the resulting drop in house prices could wreak more economic havoc than it is worth, according to research presented Thursday by a top Federal Reserve official.
"A typical estimate is that a 1 percent loss in GDP is associated with a 4 percent reduction in house prices," San Francisco Fed President John Williams said in remarks prepared for delivery in Jakarta.
"This implies a very costly tradeoff of using monetary policy to affect house prices when macroeconomic and financial stability goals are in conflict."
Central bankers have argued for years over whether monetary policy should be used to head off risks to financial stability when poor economic conditions would not otherwise call for higher interest rates. Williams's own research and his interpretation of a range of other studies presented at the Bank Indonesia-BIS Conference bolster the argument that it should not.
That, of course, does not mean Williams opposes raising U.S. interest rates fairly soon. To the contrary, he has said previously he believes the Fed should probably raise interest rates a couple of times before the end of the year.
"If the housing sector and the overall economy are both booming, then tighter monetary policy may serve to both reduce the risks to the financial system and keep economic activity from exceeding desired levels," said Williams, whose bank is headquartered in one of the hottest housing markets in the United States.
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