Brad DeLong aruges for lowering mortgage interest rates to 4% to boost the housing market. I think Brad needs to re-check his assumptions:
The mortgage interest rate is made up of four things. Compensation for inflation--call it 2% per year. Real time preference--the fact that because we will be richer in the future we value future goods at less than par in terms of present ones--call it 2% per year. The default discount--which in a well-run housing market should be small. And the risk discount--the extra return mortgage lenders demand because they are not sure when their payments are going to come exactly or what they will be worth exactly when they do come--and I am under the spell of Richard Thaler and Matt Rabin who argue that this discount should also be very small.Too bad we don't have a well-run housing market. Assuming away the default discount in mortgage interest rates right now is a bit like assuming a can opener.