Interest Rates on a Slide

It’s good for real estate, but there could be a downside.

November 1, 1998

Several years ago, Federal Reserve Chairman Alan Greenspan told NAR’s Board of Directors that the Fed was in business not to change interest rates but rather to create conditions that precluded any need to change them.

For the past three years, he has lived up to his word, holding rates steady in the face of momentary mini-panics in the financial markets over whether the economy was too hot or too cold.

Now the Fed has moved.

In late September, the Fed reduced the federal funds rate by a quarter point. The justification for the move was manifold. The primary impetus came from the crisis in Asia and the collapse of the Russian economy. With the interrelationships now driving the world economy, these problems have the potential to bring down the economies of a host of other nations.

More important, the troubles in some economies throughout the world would trigger defensive currency devaluations similar to those of 1929–31, an era we'd scarce like to repeat. The interest rate cut was intended to increase U.S. demand for imports and bolster other countries. So the first reason for the drop was international.

The second motive behind the Fed's action was domestic. Because of our low inflation rate and an inflow of capital frightened by the sluggish economies abroad, long-term rates had actually fallen below short-term rates. The Fed lowered the short-term government rate to balance the markets.

Finally, the Fed moved because the markets expected it. The interest rate policy of the Fed is transparent to keen eyes on Wall Street. In most cases, the markets anticipate a move and then react violently when they’re disappointed.

The Fed may well have been reluctant to lower the rate: The fact that the drop was only a quarter point when the market expected more suggests that the message was “We’ll move, but we don’t want to.”

Regardless of what the Fed did or didn’t do, low interest rates are here to stay. They're a product of our disinflationary environment, which in turn reflects the fall of commodity prices throughout the world. This will continue for the foreseeable future. So rates have fallen over the past year and will continue to fall.

That will sustain the real estate sector, which will in turn keep the economy growing. Lower rates will increase the demand for housing and make commercial deals more attractive. Although interest rates have been a minor factor over the past several years, they now loom higher in importance because of the stock market slump.

Yet, there are still worries. Low rates can result from a good, strong economy in which there are little if any price pressures. That’s good and appears to be the model for the economy of the late nineties. Low rates can also be the product of weak demand worldwide because of depressed economies and falling prices. That’s the model of the thirties and one we can’t afford to see. The danger is that this latter model, not the former, is the future.

To figure out which future is the most probable, keep your eyes on the world economy, and particularly Japan.If the Japanese government can create the kind of policy it needs to pull its economyout of recession, as it appears it’sdoing with great reluctance, we’ll be OK. Otherwise, lower rates are a symptom of the disease and not a cure for what ails ya.

Tuccillo ( is consulting economist for NAR and president of JTA Inc., Arlington, VA. He's served as director of the Center for Housing and Community Development at the Urban Institute and as a consultant to the U.S. Department of Housing and Urban Development.

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