Conversations with the St. Louis Fed (Audio)

a big day for the bank. And Homer George started about sixty plays years ago what nowadays you know, became FRED, our main data tool. Anybody can come to FRED and look at their data. We have more than a hundred thousand seats. And that started as an innovation thing back in the nineteen sixties by Hommer Johnes. So it's great to honor his memory. Okay, Well, one of your areas of research is housing, the housing market, mortgage rates, how

it all feeds through the economy. And given what's going on in the US housing market, I want to start with that. Uh, particularly this this turn in the housing market three on the thirty year fixed roughly up to about seven percent. It feels like it happened in a matter of weeks. It hit the market so hard. When have mortgage rates done this in the past. Is this almost unprecedented? Are we seen something like this? Well, we had hybrid is raised in the past, you don't have

to go that far. In nearly two thousands and even in the late nineties we had mortgage rates at digit level. But such a rapid turn in a matter of you know, two quarters, it's kind of unprecedented. We had, you know, a sizeable increase in the early two thousand and five or so, but it has been ratily dramatic. But we also had a very rapid increasing inflation in the second half of one so we have to be mindful about how quick inflation escalated. And I think that's just, you know,

the appropriate reaction given how quick inflation moved. Sure well, And one of the axioms in monetary theory people say it over monetary policy has long and variable lags. There was not much of a lag between the way progressive rate hikes, particularly once the FED picked up the pace,

and what happened to mortgage rates. Uh As transmission of monetary policy in some fundamental way changed, well, I mean, this is kind of the same from the nineteen sixties and nineteen seventies, and we all understand that the economy is very different fifty years later. We have a much more developed financial market and credit is a key player. So it really transmit to create a sensitive sectors. But non created sensitive sectors are also connected to create sensitive sectors.

And really stated a classical example, when we increase rates more, you know, the coastal borrowing goes up, and that reduces the demand for housing. The properties usually stay a bit longer in the market, and there's a lot of purchases that are tied to housing. People that buy a new house, they often buy dotable goods and so on and so forth. So that really connects the housing sector to the rest

of the economy. And and so the lacks that would argue have been reduced dramatically, and housing is one of the sectors that is more interconnected to the rest of the economy, not only in terms of the value added, but also in terms of employment. Employment growth in the construction sector also leads employing growth in other sectors in the economy. And that's what we see from looking at deep without put table, and it's very different now than it was, you know, about fifty years ago, so we

have to be mindful about that. So being mindful about how it's changed, What does that mean for the economy, What does it mean for UH monetary policy? And I mean central banks broadley. This is just ant happening in in the US with the FED, It's happening with other central banks around the world. It's certainly not unique to the US. And housing markets in essence are similar, but

financing markets for housing are very different across countries. We have across the border Canada that has a very different housing finance market, and we see that throughout Europe. So that really changed the transmission mechan is, and that's a key feature of how you know, financial markets are connected with the real economy, and we have to be mindful about how that change the transmission mechan is in terms of the size but also in terms of the speed.

A lot of countries now are seeing their hormoners facing sizeable research, whereas in this country the majority of hormoners have fixed laans. So in some sense inflation is really the fleeting the real value their aim, and so transmission is going to be very very different, and we went through a massive refinance emperiod in the last couple of years, so there's a lot of you know, disposable income in

the part of the households. And what about mortgage debt and what's difference now from the nineteen seventies, Well, the shadow mortgage they're relative to disposable income in the nineties seventies eighties was substantially lower than what we have right now and now it's what before it was roughly about fifty So that's just a big change in terms of

the volume and also in the composition. In the late seventies early eighties, that was when the baby generation was entered in the housing market, so we were expecting a big increase in real estate prices. That didn't happen because of the high inflation. Now we have those households and the tailing of the life cycle and they're in a very different position. And now we have the millenniums getting into the market. Plus the COVID chock really changed a

whole lot of things. So how does that feed through now when this central bank, the FED is racing rates rapidly in bigger steps? Is there some risk there with mortgage debt and debt holders, there's no immediate risk or on mortgage debt like what we signed two thousand or seven, what we would expect would be as low adjudgtment correction in the housing market, price adjustment downward. We would see

we're already seeing in some areas inventory building up. But we had inventory levels that were a normally low the average historical value somewhere between six to eight months, and we had inventory levels down to two months. So what we would expect, just like what we see in vacancy, is it's just an adjustment of correction to more normal levels. Now, it could be the case that we're in a new norm and may be a bit different from what we

see historically, but we're too far from those levels. So another trend in the last few years has been private investors buying up lots of a real estate and not just multiple family dwellings but single family homes. Uh where does that stand now? And what does that mean for home affordability? Because there you can find individuals at oh I couldn't buy the house for what two hundred fifty

seven thousand dollars that I thought I could. Now those prices are over four hundred thousand because there's so much demand from private investors. What we're gonna see now is to what extends some of the trend that really started to pick up in two thousand nine two thousand eleven, in which you know, investors moved from equity about market

into real estate market could be reversed. These investors, they provide a fair amount of liquidity across the U. S landscape, not only in the big cities and vacation in areas, but throughout looking for yields. And what we're finding is that now it could be a perfect opportunity for them to kind of cash out the capital games that they

have a crew pretty much in the last decade. If you bought in two thousand and twelve and you have, you know, had substantial cashuals coming out of certain properties because you were listening them out, now may be a good opportunity for you to kind of liquidate that investment position and move to other markets. And that might be a trend that we may see and that should help to mitigate the affordability crisis. If you bought in two thousand and twelve, you have plenty of it within the property.

So even if you see a market correction where prices decline you used to on a pretty good territory, and I would assume not not the hugest part of the business landscape, but in terms of the profitability or how strong they are fundamental, because there's a lot of concerns now about debt that the companies are holding. Uh, it seems that if they if they bought low and are selling high, they're in a position now they should be I would expect. So, I mean, I'm not concerned about

that positions at this point. As we were in two thousand and five to two thou seven, that was more of a concern. We had abundant supply coming to the market at a period where you know, inventory was spilling up and prices were decreasing and incomes were at risk. Whatevery different situation with the current lebal market. We're still a lot of mobility. Is a very strong leberal market, one of the ones, the strongest one that we have

seen in the last three decades. So that concern coming from the leberal market that ultimately funds those mortgage payments does not seem to be there right now, at least what we can see the near term and the households have plenty of equity and pretty much everybody had to refinance the refinance in the last couple of years to putty a little mortgage rates. So final question, if Homer Jones were here, and he would we're advising you on your your next project when it comes to housing mortgages.

This area of the economy US globally is become so important. What would he be advising you to look at? I mean, that's an excellent question. I guess that the challenge going forward is going to be internationalist billovers. How economy is bouncing back from this COVID pandemic, plus the underlying structural the changes are going on in the economy is going to shape everything. We're seeing geo political changes and everything kind of feeds into everything, and that's going to pose

interesting challenges. But we do know that, you know, the U. S economy is one of the strongest one globally, and we're seeing that with this frank of the dollar. When things are uncertain, the dollar picks up a lot of the strengths. I would say that we would still maintain that position and and that's kind of good news for us. All Right, Well, Karlov Karriga, thank you so much for joining us today here at the Federatory Bank of St. Louis on this very important Homer Jones Memorial Lecture day.

And plus they're always happy to have you equal all right, Paula Matta, having a great time starting the day off with a very interesting conversation, and the course will be continuing throughout the day. I'm very happy to welcome to Bloomberg rade you at the Federal Bank of St. Louis on this very important day when they honor one of the top economists in the country with the Homer Jones

Memorial Award and he gives a lecture. Sar prasade As he said, professor of Cornell University, Senior Fellow of Brookings and the author of another new book, The Future of Money, How Digital transfer revolution is transforming currencies and finance. On a busy day for you, Glad you could find the time as well. It's a pleasure, Kathleen. So you've written papers, two books about the dollar, its role in the world.

What drew you to cryptocurrencies and all the changes it's it's doing and actually signaling, You know, I hang out with central bankers a lot and a few years ago, questions started arising about what the digital revolution might mean for banking financing, particularly for central banks. So my plan was to think about central bank digital currencies CBDCs and

what role they might play in in finance. But it quickly became apparent to me that one needed to think about basic developments taking place in financial markets as a

result of technology, which goes under the term fintech. Then to think about cryptocurrencies and what they might mean for finance, and then central bank digital currencies and what it might all mean for the structure of financial markets and institutions, central banking, and indeed the international monetary system, which is why what was meant to be a slim little volume turned into a five page tom I want to jump into that, but I just have to ask you quickly.

Were you a little bit horror fight as you saw bitcoin shooting up as high as a cart falling back down, knowing that a lot of small investors who maybe have invested much for getting swept along and maybe a not

so good way into this cryptocurrency world. You know, Kathleen, one of the great joys in writing this book was learning about the technology underlying bitcoin, and it's a phenomenal technology if you think about what bitcoin is trying to accomplish, being able to conduct transactions without using a trusted intermediary, without even revealing a digital identity, actual identity, and just using a digital identity, it's phenomenal. But bitcoin was meant

to be a medium of exchange. Instead it's become a speculative financial asset, and as you've pointed out, many people seem to have gotten taken in by the razzle dazzle of the new technology, don't understand what risks they're taking on. And if you're a wealthy investor willing to take a roll of the dice, it's one thing. If you're an unsophisticated investor putting a lot of your life savings on the line, that is a buddying proposition. And certainly the

bitcoin price alatility has given us a lot to worry about. Well. Central banks concerned about financial stability of decentralized payment systems UH stable coins and how they can displace cash, you know, traditional systems. At the same time, they're moving very slowly, carefully, i might even say reluctantly to develop CBDC central bank Digital coins. Yeah, I think all central banks rightly think about the dangers of stepping in where the private sector

could provide services equally well. And there is clearly a need for better payment systems, both domestically between consumers, between consumers and businesses between businesses, and also the international level where there are huge frictions in terms of payments. So when you think about cryptocurrencies like stable coins, they're trying

to meet a real need. And of course, in many developing countries and advanced economies around the world, the private sector is doing a great job of providing low cost, easy access digital payments. So the question is what is the value proposition for a CBDC, And I think central banks are rightly concerned that it could lead to some risks of financial instability, disintermediation, the banking system, perhaps private sector innovation in terms of payments being limited, so they're

treading very cautiously. But one thing that's clear is that we definitely need better payment systems because after all, that's the key lubricant of any market economy, and if it doesn't work well and efficiently, there are things that could be improved. So how big is the threat of these digital payment systems to commercial banks. From the beginning, it's been Oh, if people don't put their deposits in JP Morgan and Bangup America and other places, that's going to

be a problem. So stable coins are an interesting element of this discussion, and of course they could post a threat to banks if they become seen as a deposit taking institutions. Now, the interesting irony of stable coins, of course, is that they completely wciate what Bitcoin was supposed to accomplish, which is a departure from the dependence on fiard currencies.

Stable coins get their stable value precisely by being backed up by stores of fiat currencies, but many stable coin issuers do provide interstrates, and there is a concern that if people see stable coins as being more functional in terms of payment mechanisms and perhaps even offering higher interstrates and bank deposits, then you could get a disintermediation of the banking system. You could also have instability in the

financial system coming from stable coins themselves. That risk, I think is somewhat mitigated by the fact that stable coins need to be backed up one to one, so they didn't affect narrow banks. It's not a huge threat but there are other risks of the financial system we need to worry about. You know, it's interesting because we look at emerging markets, developing economies and all the advantages they could get from these digital payment systems, stable coins, etcetera.

But you see some risks I don't know. I everybody thinks about two emerging markets in this transition. You know, a friction free international payments are a wonderful thing for economic migrants send remittances back to their home countries for small and mediumental prices, trying to access global pools of capital, for investors looking for international portfolio diversification opportunities. But you could have digital versions of the dollar of their in

min b being easily available in the future. You could even have stable coins issued by major corporations UM such as Amazon and perhaps one day Meta will provive with stable coin project. These currencies, either private or official, might be trusted more than the currencies issued by non credible

central banks UM in small open economies. So there is an existential threat I think to some of these smaller currencies, especially currencies and economies that are mismanaged or where the central banks are not credible, so there's their currency could

get tanked. That's right, You could bear a real shakeout because everybody in the country might decide that it's easier to trust the currency issued by one of the major economies or even one of the major corporations, because they have deeper pockets and are more trustworthy than the domestic central banks. So this could be a problem and dollar dominance, I think maybe are some people are sort of hoping that also push the dollar back a bit and their

currencies can rise, and that's going to happen. What do you think that is the great hope that perhaps digital technologies will provide a way to displace a dollar in this medium of exchange or store of value function. Perhaps if the digital uan were to be easily available, you could see it getting a little more traction and international payments. But the reality is that people are not going to trust the currency just because it's available in digital form.

They care about what lies behind the currency, you know, deep and liquid financial markets, but more importantly, what is necessary to engender the trust of foreign investors and domestic investors. There is an institutional system such as an independent central bank and a system of checks and balances. All of these are really important to inspire the trust of foreign investors.

I don't think there is any other economy um that has the financial and economic might the US does and is also backed up by an institutional framework of this sort. So I don't think the dollar is going to be significantly threatened anytime soon. Getting outside the crypto around for a minute, Uh, strong dollar getting stronger all the time. I am a World Bank meetings last week. It's a concern. They say, go ahead, keep doing those rate hikes. But what kind of risk do you see? What are your

concerns about this dollar that continues to strengthen. What it means for the rest of the world. Well, it's a sign of two things. One is that the US economy has slightly better prospects, even though not great prospects, relative to the rest of the world. And there is a desire for safety. Right now. There is a great deal of financial and economic termoil around the world, and people

still look to the U. S Dollar for safety. So this is a bit of a paradox because a strong dollar helps the U S a little bit of the margin it makes important goes a little cheaper here, but the positive effect is not that large. But for countries around the world whose currency is are depreciating against a dollar, it means more domestic in lationary pressures because lots of international trade is still priced in dollars, so the prices

and domestic currencies of those goods go up. The cost of financing debt um that is UH and servicing debt that has been denominated in dollars is very high. So for the rest of the world it's a huge negative. So this asymmetry is a real problem for the world economy. But right now there doesn't seem to be any easy way out of it because the FED has to do what it needs to do because otherwise we could get

higher rate hikes and even more economic pain down the road. Now, you, as represent are giving the Homo Jones Memorial lecture today quite an honor. Is there some point you're making in that lecture You can't tell us exactly what you're saying that that we would likely like to leave us with today. I think it's going to be an interesting era of competition in various forms of money um as we just discussed.

I think that is going to be competition between privately issued moneies and central bank FIAT currencies in the medium of exchange function even at the international and I can see digital versions of some currencies beginning to, uh, you know, at least compete with the dollar more effectively. So a lot more interesting currency competition, and as an economist, I think competition is a good thing, all right. Thank you

for joining us. Professor at Colonel University, senior fellow at the Brookings Institute, and the author of a new book, The Future of Money, How the Digital Revolution is transforming Currencies and Finance. Thank you for joining us today here at the St. Louis fed on Bloomberg Radio. It's been my pleasure. Kathleen