Not whether to taper, but how: Does the Fed worry more about stocks or housing?

BY Catherine Mann  December 17, 2013 at 5:07 PM EDT

Tuesday was the first day of meetings of the Fed’s Open Market Committee — the body tasked with deciding if and when to taper, or lower, the Fed’s purchase of Treasury bonds and mortgage-backed securities. Making Sense explored the tapering question in the segment above, which aired on the Fed’s centennial.

But, the decision the FOMC faces is not simply if to taper, but how. As former Fed economist Catherine Mann, now at the Brandeis International Business School, points out, there are nuances in the Fed’s quantitative easing policy, and therefore, there are nuances in the way they could decide to taper, too. The FOMC will announce their decision Wednesday. Read more of our conversation with Mann here. Paul Solman: So what do you expect the Fed’s going do?

Catherine Mann: I don’t think they’re really going to do anything until later in the second quarter of 2014.

Paul Solman: And what are they going do then?

Catherine Mann: I think the real question for them is, should we reduce the purchases of U.S. Treasuries and mortgage-backed securities by the same amount or should we focus on reducing purchases of U.S. Treasuries, but continue to purchase asset-backed securities and mortgage-backed securities at the same pace?

Paul Solman: Why?

Catherine Mann: Well if you look in the past, … the Federal Reserve has used both of these types of purchases, Treasury purchases and mortgage-backed securities. Now, these have different implications for the economy, and the reason why is that when you buy the mortgage-backed securities, it’s particularly potent for affecting housing prices and mortgages.

Now the distribution of who holds a mortgage as their wealth versus who holds stock in their wealth portfolio, that distribution within our population is very, very different, and so there’s been this question about whether or not the quantitative easing strategy has disproportionately benefited the upper end of wealth distribution, who own stocks.

Paul Solman: Because of keeping interest rates low….

Catherine Mann: If it’s low; the stock market price goes up, and if stocks are a large component of your wealth portfolio, you’ve done very well.

Paul Solman: And that’s true.

Catherine Mann: And that’s very true, and that was the objective of the policy; that’s the asset channel. But there is another asset that is very important in people’s portfolio at the lower end of the distribution, not the 1 percent; I mean, they have a house too, but it’s not really very important in their total portfolio. But for the middle class, the bulk of their wealth is in their house and when…the purchases under quantitative easing that are specifically the asset-backed securities, or the mortgage-backed securities, when those purchases aid the housing market, that part really helps the middle class, the construction industry — the traditional ways that cheap money has led to growth.

Paul Solman: And that’s because if the Fed buys mortgage-backed securities, it means that somebody who is issuing a mortgage can issue it at a lower interest rate, which means it’s cheaper to buy a house if you borrow the money, and it means that it’s more likely that you’d build a house, which would then hire people within the construction industry.

Catherine Mann: And the third element, of course, is that a lot of these mortgage-backed securities are already in the market place, and so when there’s greater demand for those mortgage-backed securities, it supports the housing market overall, which means everybody who currently has a house and has a mortgage, their house price goes up, and so they have wealth in their houses, or home equity.

Paul Solman: And then they might spend some of that wealth.

Catherine Mann: Yes, they might spend some of that wealth. Again, that’s one of two types of assets: stock assets that are really at the top end of the wealth distribution and home-ownership assets or home assets that are at the middle class of the distribution. So if we think about some of the nuances of how quantitative easing has been used, I think we might see some differences and some nuances in how the tapering strategy will be implemented.


This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions