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Housing Is the Business Cycle - July 3, 2018

“It’s a consumer cycle, not a business cycle”

Being students of the markets, we are also students of history. Despite the occasional cry of “this time it’s different”, we tend to go with the aphorism that “Those who cannot remember the past are condemned to repeat it”. As such we occasionally find ourselves going through “oldies but goodies” of economic research and dove this week into a paper from Edward Leamer from UCLA titled “Housing Is the Business Cycle”, which was presented at the Jackson Hole Symposium in September 2007. The paper, coming in the midst of the housing downturn that presaged the GFC, but before the start of the recession proper, looks to “provide unforgettable images that leave a lasting impression regarding the importance of housing to what we call the business cycle.” 

In addition to providing clear and thoughtful analysis on the dynamics surrounding past recessions, it is amusingly written and worth the time to read in full.

Among the highlights:

“For housing it’s the cycle that is persistent. Once the cycle starts, it keeps on going... The best time to fight the housing cycle with tight monetary policy is when the wave is starting to rise, not when it is cresting.”

“Our market system relies on price flexibility to assure that labor and capital are productively employed, but house prices are very inflexible downward, and when demand softens..., we get very little price adjustment but a huge volume drop.”

“For long-run growth, residential investment is pretty inconsequential, but for the wiggles we call recessions and recoveries, residential investment is very very important.”

“In words, residential investment consistently and substantially contributes to weakness before the recessions”.

“After residential investment as a contributor to prior weakness come consumer durables, consumer services, and then consumer nondurables. Those are all consumer spending items – it’s weakness in consumer spending that is a symptom of an oncoming recession.”

“[O]nce inflation gets going, it tends to hang on for a long time. This is understood by our monetary authorities who are quick to stamp out the inflation fire before it gains a foothold.... For housing it’s the cycle that is persistent.”

“Though the housing wealth effect on vehicles is doubtlessly real, it operates with the kind of delay that is unlikely to connect housing wealth with durable spending rapidly enough and intensely enough to explain why spending on consumer durables declines within a quarter of the housing volume decline even though price adjustment is much delayed. So it’s the common driver: interest rates and employment.”

And forebodingly both then and now:

“The negative wealth effect we are now experiencing from housing is going to affect each of us in different ways at different points in time. That’s a recipe for sluggish growth, not a recession” (Oops!) And finally, “We do not want a monetary system that allows us to put phantom assets onto our balance sheets and that signals to us that hard work and savings are not needed to prepare for our retirements.”

Again, though slightly dated at over a decade old, the paper is a pleasure to read and emphasizes why, when it comes to spotting potential weakness, it’s vital to watch housing.