Impact of Lumber Price Increases on Home Construction and Economic Policy

In recent times, the skyrocketing price of lumber has sparked considerable debate regarding its potential impact on the Biden economic agenda, particularly for new construction homes. Many argue that if the price of lumber were to increase, the Federal Reserve (Fed) might consider keeping interest rates low to mitigate the financial burden on homeowners. However, the reality of the situation is more complex. While the Fed does play a significant role in the economy, its primary focus is not to cater to any specific agenda, whether local, state, or federal.

The Role of the Federal Reserve

The Federal Reserve operates on a broad basis, addressing a wide array of economic factors rather than focusing on just one aspect, such as the cost of lumber. In light of the current debate, many argue that the Fed should keep interest rates low to offset the rising cost of construction materials. However, this is not necessarily the case. The Fed is primarily focused on maximizing economic growth and employment while keeping inflation in check.

Zero Population Growth and New Home Construction

Despite zero population growth, the number of new home constructions remains high. This has led to questions about the purpose and necessity of building so many homes, especially when the population is not increasing. Experts suggest various factors for this trend, including demographic changes, migration patterns, and economic incentives. Nonetheless, it's clear that housing remains a significant part of the economy, even in times of zero growth.

Why the Fed Keeps Interest Rates Low

While it might seem advantageous for the Fed to reduce interest rates to lower monthly payments for homeowners, especially as material costs rise, this is not typically their focus. The Fed does not directly control the rates in the private sector, which are established in the free market by banks. Instead, the Fed sets the 24-hour interbank lending rate. Although in 2020, they made an exception by manipulating the rates of ten-year Treasury bonds to ensure mortgage rates remained low during the pandemic, they generally do not intervene in long-term rates.

The decision to keep interest rates low is often influenced by broader economic considerations, including consumer spending, investment, and overall economic health. For instance, during times of economic uncertainty or recession, the Fed may lower interest rates to stimulate borrowing and spending, thereby boosting the economy.

Understanding the Relationship Between Lumber Prices and Interest Rates

It's important to understand that the price of lumber is just one factor affecting the housing market. When lumber prices increase, it can certainly impact the cost of building and renovating homes. However, the Fed's primary goal is not to address these specific market fluctuations. Instead, they focus on broader economic indicators such as inflation and employment.

When inflation rises, the Fed typically raises interest rates to slow down the economy and reduce demand for goods and services, including new homes. This is a standard monetary policy tool to manage inflation. Therefore, while the price of lumber does influence home construction costs, it is not a direct factor in the Fed's interest rate decisions.

Another critical aspect to consider is the long-term fixings of mortgage interest rates. Once a homeowner locks in a mortgage at a fixed rate, it remains unchanged. Variable interest rates are a different matter, but for most homeowners, this is not typically a concern. Thus, changes in the Fed's interest rates do not directly impact the long-term financial burden of homeownership.

The Independence of the Federal Reserve

The Federal Reserve is supposed to be independent of any specific administration, including the Biden administration. While the Chair of the Federal Reserve is not expected to be pressured by the President or their administration, they must still be cautious and make decisions that benefit the overall economy. While the Chair of the Federal Reserve is not under direct pressure from the President, they must balance the needs of the economy with the demands of the administration.

For instance, when the President's agenda might seem to benefit from low interest rates to stimulate home construction, the Fed might still raise rates if inflation is a concern. The Fed's decisions are guided by their dual mandate of maximizing economic growth and employment while keeping inflation in check. Since 2020, they have shown a willingness to manipulate short-term rates to influence longer-term rates, but these are exceptions and not the norm.

The Current Situation: Lumber Prices and Mortgage Rates

Currently, it is worth noting that lumber prices are starting to come down. This suggests that the cost of construction materials will soon stabilize, which is generally beneficial for the housing market. However, the Federal Reserve is unlikely to lower interest rates just because the cost of lumber is rising or falling. As mentioned earlier, the Fed's rate decisions are based on broader economic indicators, and the current rates are already historically low.

The interest rates we see today reflect the Fed's assessment of the current economic situation and inflationary pressures. For example, during the 1970s, mortgage rates were around 7-8%, and banks often paid 3-4% on savings accounts. Today, savings accounts offer minimal returns, which is why many individuals opt to invest rather than save. This highlights the changing economic landscape and the dynamic nature of interest rates.

Conclusion

While the rising price of lumber can impact the housing market, the Federal Reserve is not primarily concerned with specific sectors of the economy, such as lumber or home construction. Instead, their focus is on broader economic indicators and the dual mandate of maximizing economic growth and employment while keeping inflation in check. The relatively low interest rates are a reflection of the current economic conditions, not a direct response to the price of lumber.

The Biden administration, like any other, is supposed to operate independently of the Federal Reserve. While the Chair of the Federal Reserve is not pressured by the President or their administration, they must still balance the needs of the economy with the administration's goals. The rising or falling price of lumber will affect the housing market, but the decision to keep interest rates low is based on a wide array of economic factors, not just the cost of one material.