Question

The government has a great deal of influence on Real Estate Finance. The Federal Reserve headed by Chairman Jerome Powell works toward stabilizing the financial markets. Explain in your words as if you were talking with a friend or family member the difference between Fiscal Policy and Monetary policy as the government uses these tools to influence Real Estate Finance.

Answer 1

The government has a great deal of influence on Real Estate Finance. It has two broad tools for that i.e. Monetary policy and Fiscal Policy.

Lets first understand what these two policy tools are, before understanding how they influence the Real estate Markets.

Monetary policy is primarily concerned with the management of interest rates and the total supply of money in circulation and is generally carried out by central banks, such as the U.S. Federal Reserve. With the help of this tool, the government controls the total money flow in the economy. There are three major policy instruments available to the Federal Reserve: (1) the open market purchase and sale of U.S. Government securities, (2) changes in the reserve requirements of member banks, and (3) changes in the discount rate, i.e., the interest rate charged to member banks by the Federal Reserve.

Fiscal policy is a collective term for the taxing and spending actions of governments. In general, two different types of fiscal policy instruments are available to the federal government i.e revenue policies and expenditure policies. Revenue policies or tax policies are those policies which determine: (i) personal income tax rates, (2) corporate profit tax rates, (3) indirect business (excise) tax rates, and (4) contributions to social insurance (social security and Medicare). Expenditure policies are tools with which the governmental policy makers may increase or decrease governmental expenditures in the form of (1) transfer payments or (2) purchases of goods and services. Transfer payments include payments to individuals in the form of social security benefits, Medicare benefits, unemployment compensation, and so on.

Effect of Monetary policy on Real Estate

Policies which tend to increase the supply of money available in the economy will lead to reductions in interest rates. Lower interest rates stimulate consumption and investment. Increased consumption and investment mean higher aggregate demand as well as increased personal income and employment. In terms of the housing market, lower interest rates imply lower credit costs; and, in theory, lower credit costs should stimulate the demand for housing

Effect of Fiscal policy on Real Estate

The line of causality which links governmental fiscal policy with housing market is far more complex than it is with monetary policies. Changes in governmental fiscal policy affect aggregate demand (GNP) both directly and indirectly through a series of complex multiplier and feedback mechanisms. Changes in GNP may, in turn, affect disposable personal income, income distribution, employment, price levels, and so forth. Real Estate markets are sensitive in varying degrees to each of these economic parameters.

To summarize the above, It can be safely assumed that, anything that helps in increase in disposable income positively affects the real estate market and vice versa. A lenient monetary or an expansive fiscal policy will tend to increase the GDP and the per-capita income which will benefit the real estate market. Conversely, a tight monetary policy or a contracting fiscal policy will restrict the money flow and reduce the average income levels which will negatively affect the real estate.