Although I expected some slowing due to the rise in mortgage rates in the middle of 2013, the extent of the slowdown has surprised me given that the recent pace of housing starts – roughly 1 million per year – is far below what is consistent with the economy’s underlying demographic trends. I think housing has been weaker than anticipated because several significant headwinds persist for this sector. First, mortgage credit is still not readily available to households with lower credit scores. Second, some people are coping with higher student loan debt burdens that have delayed their entry into the housing market as first-time homebuyers. This, in turn, makes it more difficult for existing homeowners to sell and trade-up. Third, there may be some ongoing difficulties increasing housing supply. The housing downturn was very deep and protracted. It takes time to shift resources back into this area. Also, in some markets house prices still appear to be below the cost of building a new home. Thus, in those markets, it remains uneconomic to undertake new home construction. Although I expect that  2  BIS central bankers’ speeches  the housing recovery will resume, the pace will likely be slow, especially relative to past economic recoveries. With respect to the outlook for prices, I think that inflation will drift upwards over the next year, getting closer to the FOMC’s 2 percent objective for the personal consumption expenditure (PCE) deflator.
Delaying the end of reinvestment puts the emphasis where it needs to be – getting off the zero lower bound for interest rates. In my opinion, this is far more important than the consequences of the balance sheet being a little larger for a little longer. With respect to the issue of how the FOMC will control money market rates with an enlarged balance sheet, the Federal Reserve already has the necessary tool – the ability to pay interest on excess reserves. However, the degree of control could be further buttressed. Enhancing confidence in the Fed’s ability to control money market rates, and hence, inflation, might also help keep inflation expectations well anchored. BIS central bankers’ speeches  5  One method the Fed has been testing is an overnight, fixed rate, reverse repo (RRP) facility. The Federal Reserve posts a fixed interest rate and accepts cash from counterparties, which include some banks, dealers, money market funds, and government sponsored enterprises, on an overnight basis in return for a security. The repo facility is “reverse” because the direction in which the funds and securities move – participants are lending funds to the Fed rather than vice versa. Users of the facility are making the economic equivalent of an overnight collateralized loan of cash to the Federal Reserve. If implemented, the facility could be set up as “full allotment,” which means that there is no cap on the amount of funds accepted from any of its counterparties at the posted overnight interest rate.