Interesting new paper here from UCLA’s Ed Leamer in which he argues that housing is the business cycle:
“Of the components of GDP, residential investment offers by far the best early warning sign of an oncoming recession. Since World War II we have had eight recessions preceded by substantial problems in housing and consumer durables. Housing did not give an early warning of the Department of defence Downturn after the Korean Armistice in 1953 or the Internet Comeuppance in 2001, nor should it have. By virtue of its prominence in our recessions, it makes sense for housing to play a prominent role in the conduct of monetary policy. A modified Taylor Rule would depend on a long-term measure of inflation having little to do with the phase in the cycle, and, in place of Taylor’s output gap, housing starts and the change in housing starts, which together form the best forward-looking indicator of the cycle of which I am aware. This would create pre-emptive anti-inflation policy in the middle of the expansions when housing is not so sensitive to interest rates, making it less likely that anti-inflation policies would be needed near the ends of expansions when housing is very interest rate sensitive, thus making our recessions less frequent and/or less severe.”
I’d have to dive a bit deeper into this, but I do have to wonder if there isn’t a bit of recency bias in this data as real estate has disproportionately driven the US economy in the last decade. My thinking:
- Private residential real estate is only about 20-25% of private investment and only provides a narrow slice of the US economy.
- Being a rather small component of private investment, there’s not much one can decipher from residential investment data. Broader investment data is a FAR better indicator with many fewer false positives.
- Home prices, with the exception of the last 10 years, are extremely stable in the USA. Therefore, the activity in real estate tends to work with a long lag period making it far more stable than the business cycle itself.
- The last 10 years were truly a period of “it’s different this time” and I think researchers and pundits are falling victim to this bias.
BUT, with the epicentre of the balance sheet recession being real estate, we’re likely to see a good multiplier effect coming from the recent positive activity in real estate. So maybe the recency bias is warranted….FOR NOW.