THE FEDERAL RESERVE CHAIRMAN, BEN BERNANKE, recently said that the housing market is not as sensitive to monetary policy as it once was. Even so, central bank actions still have major impact on housing-market activity. This is particularly true when mortgage markets have been damaged by a frantic flight to quality in credit markets generally and mortgage-related securities markets in particular.

The Federal Reserve's reactions to the severe credit crunch that erupted in August deserve mixed reviews. Not until Sept. 18 did the Fed take decisive steps to address the evolving credit crisis. Deepening of the housing downswing since that time cries out for further monetary easing to keep housing from pulling the total economy into recession.

FIRST STEPS At the Aug. 7 meeting of the Federal Open Market Committee (FOMC), the Fed held monetary policy steady and issued a statement reaffirming the central bank's concern about potential upward pressures on core inflation—a maddening position in the face of worsening financial market conditions that were increasingly obvious to market participants and private sector analysts. But financial market turbulence really boiled over a few days later, compelling the Fed to shift gears several times in attempts to calm financial markets and contain the damage to housing and the economy.

The Fed's initial reactions (Aug. 10) were weak, simply stating that the central bank would keep the effective federal funds rate close to the unchanged target rate (5.25 percent) and reminding the world of the existence of the Federal Reserve discount window where banks could borrow at a 1 percent penalty rate. These efforts unfortunately failed to calm the markets or alleviate serious liquidity problems in short-term credit markets. Within a few more days (Aug. 17), the Fed was compelled to take bolder steps—primarily, cutting the penalty rate at the discount window in half and amending the FOMC statement between scheduled policy meetings to focus more heavily on downside risks to the economic expansion.

BIGGER STRIDES The Aug. 17 words and actions by the Fed changed market expectations about the future course of monetary policy and seemed to provide some benefit to financial markets. But financial market conditions then deteriorated further, provoking widespread speculation about an inter-meeting cut (before Sept. 18) in the Federal funds rate target. But the Fed held fast, avoiding the appearance of being pushed around by the markets. By the time of the Sept. 18 policy meeting, an avalanche of bad news on the housing market (provided partly by the NAHB), together with overwhelming evidence of tightening credit conditions (outside the Treasury market), compelled the FOMC to unanimously enact half-point cuts to both the Federal funds rate target and the discount rate—taking them to 4.75 percent and 5.25 percent, respectively. The FOMC statement focused on the disruptions in financial markets and stressed that tightening credit conditions have the potential to intensify the housing correction and restrain economic growth.

MORE TO COME? The Fed should cut short-term rates further before the end of the year, choosing to buy more insurance against a dangerous shortfall in economic growth. The NAHB's forecast assumes quarter-point cuts in the funds rate target at both the Oct. 31 and Dec. 11 FOMC meetings, followed by an extended period of stability.