“The Fed’s mode of operation has drastically changed over the past 12 years. Prior to 2002 the Fed would tighten monetary policy in reaction to outward signs of rising “price inflation” and loosen monetary policy in reaction to outward signs of falling “price inflation”, but beginning in 2002 the Fed became far more biased towards loose monetary policy. This bias is now so great that we are starting to wonder whether the Fed has become permanently loose.”
“The chart above comparing the Fed Funds Rate (FFR) target set by the Fed with the Future Inflation Gauge (FIG) clearly illustrates how the Fed has changed over the past two decades. Note that the Future Inflation Gauge is calculated monthly by the Economic Cycle Research Institute (ECRI) and should really be called the Future CPI Gauge, because it is designed to lead the CPI by about 11 months.”
“The chart shows that prior to 2002 the FFR tended to follow the FIG. After the FIG warned of rising “price pressures” the Fed would start hiking the FFR, and after the FIG started signaling reduced upward pressure on the CPI the Fed would start cutting the FFR. During 2002-2004, however, the Fed not only didn’t hike its targeted interest rate in response to a sharp increase in the FIG, it continued to cut the FFR. The Fed’s decision to maintain an ultra-loose stance during 2002-2004 was the fuel for the real estate investment bubble and set the stage for the collapse of 2007-2009 [in the US].” [editor’s note: The Canadian RE market was bailed out by parallel rate cuts here — before it had even crashed!]
“There was a lesson to be learned from what happened during 2002-2007, but the Fed apparently learned the wrong lesson. The lesson that should have been learned was: Don’t provide monetary fuel for bubble activities, because the eventual economic fallout will be devastating. Unfortunately, the lesson that was actually learned by the Fed was: An economic bust can be avoided forever by keeping monetary policy loose forever. The result is that the divergence between the FFR and the FIG that arose during the first half of the last decade is nothing compared to the divergence that is now in progress. Moreover, the near-zero FFR doesn’t do justice to the ‘looseness’ of the Fed’s current stance, in that 4+ years after the end of the last official recession the Fed is still pumping money as if the US were in the midst of a financial crisis.” …
“By ignoring investment bubbles and erring far more in favour of “inflation” than it has ever done in the past, the Fed is currently setting the stage for the mother-of-all economic busts.”
Canadian markets are completely subservient to action in the US. (If you don’t believe this, watch any aspect of a Canadian market of any sort on a US market holiday. Flatline!)
Canadian interest rates were cut in lockstep with the US in late 2008, even though the RE market here sorely didn’t need the juicing. The BOC and the Min of Finance were, and are, at fault for dropping interest rates too far, and then holding them too low for too long.
If you want to see a graphic representation of the reason for our national RE bubble, look at the orange areas in chart below (a version of the one above). [BTW, the charts here are almost a year old.. the FIG is now back around 4, and the Fed Fund rate remains zero].
The policy is perverse, and the piper is yet to be paid.