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WASHINGTON - UNITED States Federal Reserve vice- chairman Donald Kohn said the sub- prime crisis' effect on US consumer spending will likely be 'modest', though there is risk of a bigger slump.
'The number of troubled sub- prime borrowers may be sufficiently small that the direct effect will be modest,' he said in a paper dated Aug 8 for a conference in Sydney yesterday.
Still, delinquencies may make investors less willing to provide credit, prompting a 'more significant effect on aggregate spending', Mr Kohn said.
He said many consumers were counting on borrowing against rising asset prices to smooth future spending. Thus, 'an unexpected levelling out or decline in that value could have a more marked effect on consumption by, in effect, raising the cost or reducing the availability of credit'.
Mr Kohn, the Fed's longest-serving governor and former chief policy strategist, co-wrote the paper with Ms Karen Dynan. She is the chief of household and real estate finance in the Fed's division of research and statistics.
In their paper, they said that rising home prices in recent years probably played the central role in lifting the ratio of household debt to income. That makes spending more vulnerable to changes in home and stock prices and interest rates, the authors said.
By contrast, the economy is now less vulnerable to price shocks, Mr Kohn said. 'With inflation expectations well anchored, such shocks have had diminished effects on inflation in recent years, thereby reducing the need for policy reactions.'
BLOOMBERG NEWS, REUTERS
'The number of troubled
sub-prime borrowers may be sufficiently small that the direct effect will be modest.'
MR KOHN, US Fed vice-chairman
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