TJP

Are the Feds Too Late?

Byron A. Ellis

December 11, 2007

The high price of crude oil is a detriment to the economy, as is the unavailability of credit for mortgages. The Fed cannot correct the former, which is a result of instability in the Middle East, but could have influenced the later earlier. And, yesterday’s reduction in interest rate was smaller than expected and not likely to significantly affect the housing market.

Housing is important to the economy. Thus, the Feds should ensure availability of funds to finance housing. Lack of funds for housing will diminish the demand for appliances, carpet, unit air conditioners, heaters, and other components that go into new houses. Reduction in the demand for housing products will cause manufactures to slow or curtail production and lay workers off.

Clearly, yesterday’s rate reduction was not sufficient, as demonstrated by the negative market reaction. The Dow lost 294.26 points, NASDAQ 66.60, and the S&P 500 38.31.

The two factors affecting the economic are higher crude oil prices and the housing credit crunch. Economic studies have shown secular, as well as cyclical correlation between energy and output. Thus, higher energy prices are likely to lead the economy into a recession.

Hamilton (1983) noted that OPEC’s increases in 1974:1 caused output reduction in 1975:1; likewise gasoline shortages and price increases due to the Iranian revolution in 1979:2 preceded the business cycle peak of 1980:1; and increases due to the Iran-Iraq war 1980:4-1981:1 caused the business cycle peak of 1981:3.

Therefore, the Fed should have known that early management of the sub-prime crisis was paramount. Furthermore, they should have signal to the administration that instability in the Middle East will adversely affect the economy.

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