Spurring or Restraining Growth of Overall Demand for Goods and Services
This is the stated monetary policy of the United States Federal Reserve. Many people accept the Federal Reserve (Fed) as a necessary institution for the US economy, partly because very few were alive when the Fed was created in 1913, with the passing of the Federal Reserve Act under Woodrow Wilson. Additionally, the population is often propagandized from a young age about the necessity of institutions like government, the media, public school, and central banking.
My goal is not to dive into all the nuances of why central banks exist or to critique government in depth, as that conversation could go for hours. Rather, I’ll focus on how central banking affects real estate, which is relevant to most of our audience.
The Policy of the Fed
If the Fed’s goal is to spur or restrain demand for goods and services, how do they accomplish this? And how do these tactics apply to the real estate market? I’ll break this down from a broad perspective and move toward how individual decision-makers experience it in real estate.
The Fed influences the supply and demand for goods and services by manipulating interest rates and the money supply.
Interest Rates
Most understand interest rates as the extra cost on a credit card or home loan. But an interest rate is essentially the price of money — the price of borrowing money now (for a good or service) in exchange for repaying with interest.
How Does the Fed Manipulate the Price of Money? They set a few key metrics:
- Discount Rate
- The rate by which commercial banks borrow from the Fed. Higher discount rates make it more costly for banks to borrow.
- Bank Reserve Requirements
- The percentage of deposits banks must hold in reserve. Traditionally around 10%, it was reduced to 0% in early 2020, allowing banks to lend all deposits, thus creating new credit.
- Federal Funds Rate
- The target rate range for banks to borrow and lend among themselves, usually slightly higher than the discount rate.
Low discount rates, reserve requirements, and Federal Funds Rates enable banks to lend easily, creating a low interest rate environment that encourages borrowing for consumption, which recycles into the banking system, spurring a credit asset bubble.
Money Supply
Consider an example market for apples with 10 people holding $100 each, totaling $1,000. If the Fed increases the money supply to $2,000, each person might feel wealthier, but with no added production, prices increase — known as inflation.
The Fed manipulates the money supply through:
- Commercial Bank Borrowing
- Lower rates incentivize banks to borrow, increasing consumer credit through loans and credit cards.
- Federal Funds Rate
- Lower rates again encourage borrowing and liquidity.
- Reserve Requirements
- Lower reserves allow more consumer lending.
This added money, spread across millions of US consumers and worldwide, eventually outpaces goods and services production, leading to inflation.
Impact on Real Estate Market
The Fed’s policies influence real estate by affecting interest rates, which impacts credit availability. With more affordable credit, demand for real estate increases. However, supply constraints, due to zoning and construction lead times, create pressure on prices when demand rises without sufficient new housing.
Since the 2008 crisis, the Fed’s low rates spurred the economy out of recession. In 2020, with lockdowns and supply chain breakdowns, the Fed cut reserve requirements, lowered rates, and funded stimulus measures. This led to high demand for housing, refinancing, and price increases, propped up by low inventory.
Central Banks and Real Estate Investment
Higher rates make borrowing costly for buyers, lowering demand. Current homeowners with low rates stay put, limiting supply. Consequently, while home prices remain propped up by low inventory, market stability remains sensitive to development, employment trends, and buyer demand shifts.
Investors face higher equity requirements due to lower loan values, and those flipping homes or adding value to multifamily projects face viability challenges with higher rates.
Rental Market Impact: More buyers are pushed into renting, keeping demand for residential rentals strong.
Reflection
This overview isn’t a forecast, nor a critique of central banks, but rather an objective view of how interest rate and money supply manipulations influence credit bubbles we recognize as “the economy.” While most people adjust their lives around these policies, policymakers accrue wealth and power. The question remains: how long will this continue?
Recommended Reading
For more insights, explore works by these economists:
- Murray Rothbard
- Ludwig Von Mises
- Thomas Sowell
- Tom Woods
- Saifedean Ammous
- Jeff Deist
- Milton Friedman
- Walter Block
- Peter Schiff
- Other Austrian economists
