Housing Slowing Growth of U.S. Economy, Fed Chief Says
Still keeping an eye first and foremost on fighting inflation, Federal Reserve Board Chairman Ben Bernanke last week told the Congress that housing activity has been weaker than expected and, as a result, the Fed has lowered its forecast for this year’s performance of the nation’s economy.
“Overall, the U.S. economy appears likely to expand at a moderate pace over the second half of 2007, with growth strengthening a bit in 2008 to a rate close to the economy’s underlying trend,” Bernanke testified before Senate and House committees on July 18 and 19.
Bernanke said that “declines in residential construction will likely continue to weigh on economic growth over coming quarters, although the magnitude of the drag on growth should diminish over time.”
The Fed is now forecasting that the real gross domestic product will expand 2.25% to 2.5% this year and 2.5% to 2.75% in 2008, which is about one-quarter of a percentage point lower than it had projected in February.
“To a considerable degree, the slower pace of economic growth in recent quarters reflects the ongoing adjustment in the housing sector,” Bernanke said.
“Over the past year, home sales and construction have slowed substantially and house prices have decelerated,” he said. “Although a leveling-off of home sales in the second half of 2006 suggested some tentative stabilization of housing demand, sales have softened further this year, leading the number of unsold new homes in builders’ inventories to rise further relative to the pace of new homes sales. Accordingly, construction of new homes has sunk further, with starts of new single-family houses thus far this year running 10% below the pace in the second half of last year.”
Bernanke attributed the sluggishness of home sales, in part, to some tightening in lending standards as the result of mounting delinquency rates on adjustable-rate subprime mortgages and a recent increase in mortgage interest rates. Growth of jobs and income should eventually bolster the housing market, he indicated, and mortgage rates, despite being higher, will still remain relatively low.
“However,” he said, “even if demand stabilizes as we expect, the pace of construction will probably fall somewhat further as builders work down stocks of unsold new homes. Thus, declines in residential construction will likely continue to weigh on economic growth over coming quarters, although the magnitude of the drag on growth should diminish over time.”
On the inflation front, Bernanke noted that core inflation has moderated slightly over the past few months to a rate of about 2% for the year so far, but “with a sustained moderation in inflation pressures yet to be convincingly demonstrated,” the Fed’s predominant policy concern remains the upside risks to inflation.
He also acknowledged that one risk to the Fed’s expectation’s for moderate growth in the U.S. economy “is that the ongoing housing correction might prove larger than anticipated, with possible spillovers onto consumer spending.”
Responding to the rising delinquencies and foreclosures in the subprime market, Bernanke indicated that the Federal Reserve is conducting “a top-to-bottom review” of actions it might take to prevent a recurrence of today’s problems — including deterioration in underwriting standards, some abusive lending practices and outright fraud, and households taking on mortgage obligations they could not meet, perhaps in some cases because they did not fully understand the terms.
“Promoting access to credit and homeownership are important objectives, and responsible subprime mortgage lending can help advance both goals,” he testified. “In designing regulations, policymakers should seek to preserve those benefits.”