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May 26, 2010

Housing prices and interest rates

Everyone knows the housing market imploded in the last couple of years, with average home prices nationwide falling almost 30 percent. This was after a big run up in prices during the early part of the 2000s decade. Can you point to any one economic factor that more than any other is correlated with those ups and downs of home prices?

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"Well ... you are right: There are a lot of factors behind the boom in the housing market and then the consequent bust. But I think one clearly important factor is interest rates. We had a big run up in housing prices ... roughly from 1997 up through 2007. This was associated for the most part with a decline in interest rates, particularly those controlled by the Federal Reserve.

"For example, they moved their interest rates very much lower after the 2001 recession and after 9/11. Then beginning in 2004, it is my opinion that the Fed became very nervous about the big boom in the housing market. They wanted to cool it off, and so they increased interest rates beginning that year. And over the next two years they increased their key rate from .5 percent to 6 percent.

"Now this had a delayed effect, but clearly one of the things it did is it made buying a home more expensive. And it also hurt those folks who had taken out adjustable rate mortgages. They had to adjust to a higher rate.

"So, I'm not saying this was the only factor behind both the boom and the bust in the housing market, but clearly you can see a strong association."

Posted by deeshore at May 26, 2010 07:58 AM

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