Fed Official Defends Rate Cuts
By EDMUND L. ANDREWS
WASHINGTON, Feb. 28 — A top Federal Reserve official tonight provided the central bank's most extended defense yet against critics who have warned that its policy has fostered a bubble in housing prices and auto purchases that might pop as abruptly as the stock market bubble did nearly three years ago.
"It makes sense to build the houses and cars now, when the cost of doing so is relatively low, rather than waiting," Donald L. Kohn, a Fed governor, said in remarks prepared for delivery tonight at a conference in San Francisco.
Though acknowledging that housing prices have soared, largely because of the Fed's drastic reduction of interest rates, Mr. Kohn argued that neither the supply of housing nor home prices were "out of line with what might be expected."
Mr. Kohn's remarks came on the heels of similar but more generalized comments by Alan Greenspan, the Fed chairman, with whom Mr. Kohn has close ties.
Tonight, Mr. Kohn seemed intent on reassuring investors that a market meltdown was unlikely and also on rebutting criticism that the Fed's attempt to prop up a weak economy with low interest rates might be creating other problems down the road.
The Fed has lowered interest rates 12 times over the last two years, bringing the federal funds rate on overnight loans between banks to 1.25 percent, the lowest level in 41 years.
That policy has created a surge in the purchases and prices of homes as lower interest rates allowed people to borrow much more than they would otherwise be able to afford. It also helped shore up consumer spending, which has been the only real source of economic growth for some time as car companies offered zero percent financing deals and homeowners pulled cash out of their homes through home-equity loans.
But at least some analysts have been worried that housing prices could be poised to crash, if only because they have been rising much faster than either inflation or personal income.
Another worry is that both home-building and car production could stall badly once interest rates begin to climb back to more typical levels.
Mr. Kohn acknowledged that higher interest rates could dampen the purchases of both houses and durable goods like cars and appliances, but he added that interest rates would head higher only in response to more buoyant economic growth.
"The question is whether the stimulus to household investment, while cushioning the economic cycle in the near term, is setting the stage for greater instability in the longer run," Mr. Kohn said.
The answer, he contended, is probably not. The boom in car sales, he said, has not required the construction of factories and has thus not led to overinvestment in machinery or equipment.
And while acknowledging that the prices of existing homes have "skyrocketed" much faster than personal income in most markets, he said the lower interest rates had kept homeowners' monthly mortgage payments at manageable levels.
"Although house prices outpaced income through much of the 1990's, housing remained quite affordable by historical standards," Mr. Kohn said. And while spending on houses and cars might well moderate in the future, he said, "they do not appear set to replicate the experience of fiber optic cable."
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