The Federal Reserve’s benchmark interest rate has dropped from near zero to near 0.25% for the first time since March 2009, a sharp drop from its high of about 0.50% during the housing market meltdown.
But with the economy still in a slow recovery and housing market volatility still rampant, the Fed can’t immediately begin to pump money into the economy to slow its rate hike.
The Fed can only do so much.
Its monetary policy committee, which is made up of the presidents of the five biggest U.S. central banks, is meeting Thursday to consider its first round of $4.5 trillion in emergency liquidity injections, including another $3.5 billion in Thursday’s funding measure.
The committee is also reviewing its first set of $100 billion in purchases of Treasury securities to be made in the next two weeks.
While the Fed is likely to raise rates sooner than this week, there is a risk that it will delay its moves, potentially leaving the economy with a massive debt and credit crunch.
“The central bank is not going to raise its benchmark rate until there is some evidence that its actions will have an impact on the housing markets, and that will take some time,” said David Weidner, a senior fellow at the Peterson Institute for International Economics.
If the Fed starts to raise interest rates in a hurry, it could be one of the most damaging events in the nation’s history.
In recent months, housing has been in free fall, as investors and banks have slashed mortgage rates and other lending terms to try to keep the market from overheating.
The drop in the benchmark rate could be even more devastating for the housing economy, as the Fed cannot buy enough new homes for its own purposes without taking on more of the costs associated with the crash in the housing bubble.
On Wednesday, the Dow Jones Industrial Average fell 7.6 points, or 1.7%, to 16,852.13.
The S&P 500 index of large U..
S.-listed companies fell 0.7% to 2,532.63, while the Nasdaq Composite index of companies in technology, technology services and telecommunications fell 1.6% to 5,742.92.
Even if the Fed were to announce a rate increase, the impact on prices would be even bigger.
For one thing, the central bank’s policy action could push prices even higher, as it may have to cut interest rates to encourage lending.
That would boost the economy, and lower the cost of borrowing.
Another effect could be higher prices for housing and real estate.
The value of the median-priced home has dropped by an average of 9.4% over the past two years, according to the Zillow National Real Estate Index, while new-home sales have plunged 19.5%.
The average price of a house has declined by an additional 2.9% over those same two years.
Meanwhile, prices for commercial real estate have fallen by an even bigger 14.6%, as new-housing sales have declined 19.7%.
That could be a major drag on the economy as the number of homes being built has been falling for several years.
It could also hurt investors, as they would not be able to sell their homes as quickly as they normally would, causing them to drop their prices.
This is also a problem for the Fed, since it could see its actions as an attack on the financial system.
When interest rates are at zero, the economy has less of an incentive to invest, and the financial sector has less to lose by taking on the risk of an interest rate hike, said Jonathan Levinson, an economist at the Committee for a Responsible Federal Budget.
If rates are raised, investors would start to take a greater share of the risk.
Weidner said that if the central banks actions caused inflation to spike even higher in the months leading up to a rate hike and did not ease off any of the monetary easing, it would have a serious impact on U.N. efforts to combat climate change.
For its part, the U.K. government has also warned that rising prices would lead to a significant slowdown in the economy and the risk that the country’s recovery could be put at risk.
“We are at risk of a prolonged and protracted period of slow economic growth, which would lead not just to rising unemployment but also to a slower recovery and, potentially, to a wider debt burden for households,” Prime Minister Philip Hammond said in a speech Wednesday.
“We must do everything possible to help the recovery from the impact of the housing crash to avoid a similar situation in the future.”
This article was originally published on