Market Monetarists Jump the Shark

Scott Sumner writes,

In America mortgage debt is commonly structured so that monthly payments stay constant over 30 years. This means that during periods of high NGDP growth, when nominal interest rates are also high, monthly payments will start very high in real terms, and then fall rapidly in real terms. But your ability to qualify for a house depends on how large the initial nominal monthly payment is, relative to your current income.

Read the whole thing. The logic is this:

1. In the 1970s, house prices started rising, but they did not rise as much as during the recent bubble.

2. In the 1970s, because mortgage rates were high, even though real interest rates were low it was hard to get mortgage credit. That is what choked off the bubble. The same thing did not happen in the recent bubble.

3. High mortgage rates reflect loose monetary policy. Hence, the difference between the 1970s and the recent bubble is that this time monetary policy was tighter.

I agree that there is a “money illusion channel” between nominal interest rates and housing. Back in the 1970s, economists proposed price-level-adjusted mortgages (PLAMs) to get around this problem. If you want more background, go to MRUniversity and watch the first half-hour or so of videos from my housing course.

But….come on. The extension of the recent bubble compared to the 1970s came from the abandonment of standards for down payments. If you think that looser monetary policy would have choked off the recent housing bubble, you’ve jumped the shark.

4 thoughts on “Market Monetarists Jump the Shark

  1. Arnold, you have the causality backwards. The reason the standards for down payments were not reduced in the 1970’s is because the high monthly payments were the bottleneck for qualification. Reducing the down payment increases the monthly payment. But, in the 2000’s, the down payment was the bottleneck, so reducing the down payment at the expense of higher monthly payments was useful.
    Comparing the two contexts, we should, in hindsight, expect that this would be an obvious paradigm shift between a high nominal rate environment and a low rate environment. The low down payments in the 2000’s are an effect, not the cause.

  2. I don’t think Sumner was particularly serious. That was the most entertaining post I read that day. It put a smile on my face and made me think a little – what could be better than that?

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