Economic Letter

Central banks debate whether using monetary policy to foster financial stability through house prices is advisable. Although a rise in interest rates tends to lower house prices, it may come at a significant cost through reduced economic output and inflation. This implies a very costly tradeoff when macroeconomic and financial stability goals are in conflict. The following is adapted from a presentation by the president and CEO of the Federal Reserve Bank of San Francisco to the Bank Indonesia–BIS Conference in Jakarta on August 20.

Much recent discussion has suggested that the official real GDP data are inadequately adjusted for recurring seasonal fluctuations. A similar pattern of insufficient seasonal adjustment also affects the published data for a key measure of price inflation. Still, such residual seasonality in the published output and inflation statistics is unlikely to mislead Federal Reserve policymakers or adversely affect the setting of monetary policy.

Policymakers disagree over whether central banks should use interest rates to curb leverage and asset price booms. Higher interest rates make mortgages more expensive and could prevent borrowers from bidding up house prices to create a boom. However, rough calculations show that the size of rate increase needed to do so might also boost unemployment and push down inflation. Thus, using this type of policy tool may cause the central bank to deviate significantly from its goals of full employment and price stability.

The U.S. economy is looking quite good. Growth is on a solid trajectory, and the FOMC’s maximum employment goal is in sight. Risks from abroad are unlikely to overturn strong U.S. fundamentals. Still, the exact timing of an initial interest rate increase will depend on convincing evidence that inflation is heading back toward target. The following is adapted from a presentation by the president and CEO of the Federal Reserve Bank of San Francisco to the International Conference of Commercial Bank Economists in Los Angeles on July 8.

Policymakers often consider temporarily redistributing income from rich to poor households to stimulate the economy. This is based in part on the idea that poor households spend a larger share of their income than rich ones do. However, ample evidence suggests that the difference in spending between these groups is significantly smaller than commonly assumed. A second assumption is that redistribution through policy is more efficient than through capital markets. Whether this is true is important to consider when proposing this type of stimulus policy.

The Swiss National Bank expanded bank reserves as part of its unconventional monetary policy during the European sovereign debt crisis. The unprecedented expansion involved short-term rather than long-term asset purchases. This approach provides novel insights into how central bank balance sheet expansions affect interest rates. In particular, it illustrates how an expansion of reserves can lower long-term yields through a reserve-induced portfolio balance effect that is independent of the assets purchased.