by Calculated Risk on 4/13/2006 02:51:00 PM

At the Bankers and Business Leaders Luncheon in Kansas City, Federal Reserve Governor Donald L. Kohn spoke on the economic outlook today. Overall Kohn was very positive on the economy, but expressed some concern about the housing market:

"If the past is any guide, the effect of rising interest rates is likely to be felt most visibly in housing markets. The rate for a thirty-year, fixed-rate mortgage is up 70 basis points from its level in the middle of last year, and one-year adjustable-rate mortgages have risen more than 100 basis points over the same period. In addition, house prices have increased considerably relative to rents, incomes, and returns on alternative assets. Already there have been signs that housing demand has begun to moderate. Sales of both new and existing homes are down substantially from their levels last summer, and information on mortgage applications and pending home sales point to further softening in the next few months. With demand slowing, house prices also seem likely to decelerate. Indeed, we are beginning to see hints of moderation in some of the data on housing prices.

As a consequence, spending for new housing construction, after contributing nearly 1/2 percentage point to overall GDP growth last year, may not increase much this year. Moreover, the slowdown in house price increases could well hold back growth in consumption spending on a wide variety of goods and services. The rapid run-up in prices over the past few years and hence in household wealth, perhaps combined with the increasing ease of tapping that wealth, probably has been a major reason that households have been saving so little of their current flow of income. As house-price appreciation slows, the personal saving rate likely should begin a gradual ascent.

To be candid, however, the behavior of the housing market and the response of spending are among the great uncertainties about the economic outlook. I have sketched a benign scenario of gradual adjustment that lines up very nicely with the Federal Reserve's assessment that overall growth should slow to a sustainable pace. But our ability to predict asset prices is very limited, especially when the trajectory of those prices is shifting, as that of house prices appears to be doing right now. Moreover, we have particular difficulty in assessing how consumers will respond to changes in their perceptions of future capital gains and actual home prices. The housing market and its effects on spending will be among the areas that Tom and I and our colleagues on the FOMC will be monitoring most closely as we try to discern the emerging pattern of economic activity and inflation."