Will the Fed have to inflate to soften the worst financial crisis since the great depression?
"The decline in house prices stands to create future dislocations, like the credit crisis we have just seen,” Robert Shiller, a Yale economist, told a Senate panel on Wednesday.
The warning underlines an increasingly widespread view that the turmoil in financial markets and tightening lending conditions are early consequences of a slump in the US housing market that is only beginning.
Mr Shiller’s warning about fresh risks to the economy from the housing market comes amid signs of moderating inflation, which could give the Federal Reserve additional scope to cut interest rates further if the trend is sustained.
Consumer prices fell last month by 0.1 per cent as prices at the pump dropped by nearly 5 per cent.
Core prices - excluding volatile food and energy costs - increased by 0.2 per cent, but the annual underlying inflation rate edged down to a 17-month low of 2.1 per cent from 2.2 per cent.
”Overall, the figures support the idea that inflation is much less of a concern than it was six months ago,” said Paul Ashworth, an economist at Capital Economics.
”The Fed is lucky that inflation is beginning to behave itself again, because the housing market is in desperate need of some monetary stimulus,” he added.
Mr Shiller told the Senate panel on Wednesday that while there had been a focus “on lax and irresponsible lending standards, I believe that this loss in housing value is the major ultimate reason we see a crisis today.”
The economist said he feared “the collapse of home prices might turn out to be the most severe since the Great Depression.”
Alan Greenspan, former Federal Reserve chairman, told the Financial Times this week that double digit falls in house prices from their peaks would not be surprising.
A national fall in house prices on that scale would be unprecedented in US history and would have an economic cost several times greater than the meltdown in the subprime mortgage market that triggered the current financial crisis."