Friday, August 17, 2012

Why the prolonged economic slump? Housing.

Economist Dean Baker writes about a recent research paper from the Federal Reserve Bank of Cleveland:
The study goes on to note the extraordinary weakness in housing in this recovery and point out that this weakness could explain much of the weakness of the recovery.

While the study notes that there are questions of causation (a weak recovery could lead to weakness in housing), there can be little doubt that if residential construction had returned to its pre-recession level, as had been the case by this point in all prior post-war recoveries, the economy would be back near full employment.

Of course it is not hard to understand why housing has not recovered. The massive over-building of housing during the bubble years lead to an enormous over-supply of housing, which shows up in the data as a record vacancy rate in the years 2006-10. In the last couple of years the vacancy rate has begun to decline which can explain the recent uptick in housing over the last few quarters.

This housing story explains why we should have expected a long and drawn out recovery. There is no easy way to replace the massive loss in demand associated with the collapse of the housing sector. And, it is hard to blame the collapse on President Obama, since the overbuilding took place in the years 2000-2006 and the collapse was already well underway at the point where he took office. ...

Ultimately we will need an increase in foreign demand, meaning a lower trade deficit, to fill the gap. This will require a lower valued dollar which will make U.S. goods more competitive internationally. Unfortunately, neither candidate seems willing to make the case for a lower valued dollar, which means that we can probably expect a weak economy for many years into the future, regardless of who gets elected.

1 comment:

  1. James, good to see you still at it, injecting free market common sense into the policy dialogue. I liked seeing that Chicago home prices have been deflated to 2001 levels, because I see demand in popular areas here building. One thing political economy is not good at, is admitting to the non-comparability in size of political entities, usually called big and small countries. Singapore and the 300 million US are not comparable. Our 3 million annual population gain is the story of our generation. Unlimited demand for the basics, has to lead to a decline in the standard of living, because we are do not have a 'macro' to grow the economy at a pace that keeps up with the population growth. Only a mixed economy, which in America, i would call a decentralized macro, can produce those kinds of results. Politically we are headed for more decentralization, but the old style econ ideologues, in both camps, are afraid of a new macro. They like their old arguing points. Regards Peter Fugiel

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