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On May 19, 2006 Ben Bernanke, Chairman of the Federal Reserve System, has touched on the housing situation in the United States in his Report on Monetary Policy. In essence, the forecast of Prof. Bernanke is that there is not going to be the dreaded bubble burst predicted by so many ‘bubbleologists’ out there (who have been predicting Apocalypse Now consistently since early 2002), but that real estate appreciation is poised to slow down considerably from recent years. The second point made by the Chairman is that the slow down in real property appreciation comes as a respite for the whole economy, as the surge in housing prices has been one of the major inflationary forces in recent times.

According to the Chairman, the U.S. economy will continue to perform well for the remainder of 2006 and in 2007. To be sure, higher energy prices will probably put some restraint on economic activity for a while longer. But so long as cost of energy increases slowly, as it is suggested by futures prices, this restraint should diminish as 2006 progresses. In addition, economic activity has continued to receive some impetus from post-hurricane recovery efforts, and the reopening of facilities shut down by the hurricanes is already being reflected in the rebound in industrial production. Federal assistance will continue to buttress rebuilding activity in coming quarters.

More broadly, the major factors that contributed to the favorable performance of the U.S. economy in 2005 will remain in place. Long-term interest rates are expected to remain at acceptable (low) levels, and conditions in corporate credit markets are generally positive. The household sector is also in good financial shape overall and should stay so even if - as expected - housing markets cool down. In addition, the improved outlook for economic growth abroad bodes well for U.S. exports. However, the effects of the cumulative tightening in monetary policy should keep the growth in aggregate output close to that of its longer-run potential.

Core inflation is likely to remain under some upward pressure in the near term from rising costs, as the pass-through of higher energy prices runs its course. But those cost pressures should wane as the year progresses, offset by the slow-down presently occurring in real estate. Moreover, strength in labor productivity should continue to dampen business costs more generally. With little evidence to date that resource utilization has put appreciable upward pressure on prices, and with longer-run inflation expectations continuing to be well anchored, core inflation will remain contained in 2006 and should stay the same in 2007.

Prof. Bernanke, furthermore, commented that nonetheless, some risks attend his economic outlook, with some of the uncertainty centered on the prospects for the housing sector. He cited some observers who believe that home values have moved above levels that can be supported by fundamentals, and that some realignment is warranted. Such realignment - if abrupt - could materially sap household wealth and confidence and, in turn, depress consumer spending. But that does not seem to be the case. Citing, in fact, an upward trend in consumer spending, the Chairman commented that it was aided by a corresponding upward trend in disposable income.

Focusing specifically on real estate, The Chairman observed that if home values were to continue to register outsized increases, the accompanying increment to household wealth would stimulate aggregate demand and raise resource utilization further. With the economy already operating in the neighborhood of its productive potential, this higher resource utilization would risk adding to inflation pressures. Because of this, therefore, the Chairman welcomed the respite in real estate for the benefit of the economy as a whole, taking care to stress the fact that far from being a bubble burst, slow-down in real property appreciation is more of a ’soft-landing’. Finally, the Chairman has predicted that real estate will continue ‘to do fairly well’ for the remainder of the year.

Another major source of uncertainty, in Prof. Bernanke’s view, is the price of energy, which continues to be buffeted by concerns about future supply disruptions, especially in light of the forthcoming hurricane season Additional steep increases in the price of energy have the potential to intensify cost pressures and weigh on economic activity.

Anyone out there who cares to enlighten us some more with his bubble-bursting theories?

Luigi Frascati

Luigi Frascati is a Real Estate Agent based in Vancouver, British Columbia. He holds a Bachelor Degree in Economics and maintains a weblog entitled the Real Estate Chronicle at http://wwwrealestatechronicle.blogspot.com where you can find the full collection of his articles. Luigi is associated with the Sutton Group, the largest real estate organization in Canada, and is based with Sutton-Centre Realty in Burnaby, BC.

Luigi is very proud to be an EzineArticles Platinum Expert Author. Your rating at the footer of this Article is very much appreciated. Thank you.

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Prices of residential real estate, both asking and selling prices, have declined steadily in many markets throughout the country these past few months, but for reasons that have nothing at all to do - not even remotely - with the dreaded real estate bubble so many ‘bubbleologists’ were so fond to predict. ‘Bubbleologist’, it will be recalled, is the term I have coined specifically to encompass those individuals - all of them of majority age - who specialize in the very fine art of wasting my time.

An economic bubble occurs when speculation causes prices to increase, thus producing more speculation and subsequent price increases. The bubble bursts when prices of goods are so absurdly high that consumers either refuse or cannot afford to purchase, thus sending demand tumbling down. In essence, an economic bubble is a particular market condition, wherein prices of commodities or assets increase to levels so high as to no longer reflect the utility of usage of the commodities or assets being exchanged.

The main cause of an economic bubble is speculation. Speculation is one of the many forces that act on capital at any given time. In theoretical Economics, speculation is defined as ‘the acquisition of financial or capital assets made solely to quickly profit from fluctuations in their prices, or of goods or commodities with no real intent to consume or otherwise use them for production’. Speculation, however, does not seem to be the root cause of the price deflation occurring in many real estate markets.

The main cause of price deflation in the buying and selling of real properties seems to be due to the double effect of 1) a tightening of the money stock which, in turn, alters the cost of borrowing, i.e. a shift in interest rates, and 2) an increase in inventory supplies. Specifically the monetary policy initiated by the Maestro, Alan Greenspan and adopted by the new Fed’s Chairman, Prof. Bernanke, is now beginning to have an impact on housing markets in the United States and, to a lesser extent by reflection, in Canada. On August 8, 2006 the Rate-setting Committee of the Federal Reserve System voted to halt the interest rate hike, holding the federal funds rate at 5.25 percent. This signalled a reversal in the trend that has characterized US monetary policy for the past seventeen times in a row.

The Fed admitted that core inflation is high at 2.4 percent annualized for the half-year ending June 30, but the expectation is that it will begin to abate in the latter part of 2006. If it does not, they will start tightening the money stock once again. The Fed has long relied on three factors to keep price pressure in check: quiescent labour markets, fat profit margins and its own credibility. It remains sure of the last, but can no longer count on the first two.

This last meeting reflected the fact that productivity grew at an annual pace of just over 1.1 percent annualized in the second quarter, not nearly enough to offset a recent acceleration in wages. Which means that for all the fuss we hear about oil, labour is the commodity with the biggest impact on inflation, accounting for two-thirds of production costs. Exactly for this reason, therefore, Prof. Bernanke has made a reference and has given a warning at the meeting of August 8 of the dangers of what he terms ‘inflationary psychology’. If people suspect that faster inflation is here to stay, they will anticipate it in their wage claims and price-setting, thus confirming their own suspicions.

This warning is very well heeded, if one considers that according to a survey conducted in July by the University of Michigan, American consumers expect the prices they pay to rise by 3.2 percent over the next twelve months. And this includes, of course, housing.

The slowdown in growth evident in the last quarter and reflected in the real estate sector was not an accident. It is due to the rate increases that the Fed has voted consistently over the last seventeen meetings. The Fed’s latest projections, unveiled on August 8, forecast growth of 3.25 - 3.50 percent this year and 3 - 3.25 percent the next, slow enough to stop core inflation from rising much further.

Therefore chances are high the real estate market will continue to be generally stagnant for the next few month, with regional exception. Although no bubble is on the horizon.

Luigi Frascati

Luigi Frascati is a Real Estate Agent based in Vancouver, British Columbia. He holds a Bachelor Degree in Economics and maintains a weblog entitled the Real Estate Chronicle at http://wwwrealestatechronicle.blogspot.com where you can find the full collection of his articles on Real Estate Economics and Finance. Luigi is associated with the Sutton Group, the largest real estate organization in Canada, and is based with Sutton-Centre Realty in Burnaby, BC.

Luigi is very proud to be an EzineArticles Platinum Expert Author. Your rating at the footer of this Article is very much appreciated. Thank you.

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