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Have low mortgage rates set the stage for inflation?





In recent years, the Federal Reserve Board's monetary policy has been focused on maintaining historically low mortgage rates to support the housing market through the recession. However, the lengthy period of low long-term interest rates has some concerned that inflation looms just around the corner.

To get a better understanding of whether consumers should be concerned that a prolonged period of record-low mortgage rates will lead to inflation, we interviewed Farrokh Hormozi, economics professor at Pace University, and Ray Hill, an economics and finance professor at Emory University.

Q: With the Federal Reserve's “easy-money policies” designed to combat the recession and promote economic recovery, some people are worried that we are setting the stage for a bout of hyperinflation. Do you think this is a valid concern; and, if so, why?
Farrokh Hormozi, Ph.D.
Chair of the Graduate Public Administration Program and Economics Professor at Pace University

A: Fear of inflationary effect from monetary policy such as we've seen from the Federal Reserve Board in recent years is not new. More than four years ago, people expressed concern that the “easy-money policy” of the Fed, particularly the quantitative-easing policy (QE), would lead to inflation - and rightly so, except for one thing. The underlying foundation of this effect is based on the simple, erroneous assumption that easy money generates excess demand feeding inflationary pressure.

This is elementary economics; however, there are two problems with this assumption:

First: The argument may be - or in fact is - valid in a closed economy, but not for the economy of the United States. In a closed economy, a limited-supply condition cannot support the excess demand generated by injecting additional money into the closed economy, thereby triggering inflationary pressure. But the American economy is not a closed economy, and the experience of the past quarter century supports that argument.

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