Posted by: Dirk | April 25, 2007

US monetary policy and the housing slump

With the housing market in steep decline, Krugman’s speech from last October seems to be quite interesting:

The thing to be worried about is the difficulty of a policy response. We normally count on the Fed to respond. (Bernanke, on the whole, has had his judgment on rates vindicated.) But if this turns nasty, what will the Fed do? They will cut rates. And will this help? Where is the traction on the real economy? The problem is that rate cuts stimulate the economy mostly through the housing and construction market. In truth, business investment is not sensitive to the Fed and consumers don’t respond. Housing is where the rubber meets the road. So that is a worry.

Fiscal policy seems to be stretched to the limits, financing the whatever-they-think-they-are-doing in Iraq, so the US might be running out of policy options. If the housing bubble gets worse (and why should it not?), Roubini’s prediction of a hard landing seems certain to be correct.

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