Archive for the Category housing market


What Caused the Great Moderation? And was it sudden or gradual?

There’s a new Vox article by Lola Gadea, Ana Gomez-Loscos, and Gabriel Pérez-Quirós showing that the Great Moderation that began around 1984 is still intact, despite the Great Recession.  This got me thinking about the cause or causes of the Great Moderation.  In the end I’ll argue there were two causes, and that the moderation actually occurred in two steps, first in 1961 and then in 1984.  Here’s a RGDP growth rate graph that clearly shows a decline in volatility after 1984:

Screen Shot 2015-10-26 at 10.52.51 AMThe first idea that popped into my head was that industrial production is unusually volatile, and has been becoming a smaller share of our economy.  When did this start? I don’t have data on IP as a share of the economy, but this graph shows that manufacturing has been shrinking as a share of GDP, and manufacturing is the vast bulk of IP.

Screen Shot 2015-10-26 at 10.56.11 AMSo maybe the Great Moderation simply reflects the shrinking share of this highly cyclical industry. Unfortunately, further research disproved that theory, as even IP has been getting much less volatile over time:

Screen Shot 2015-10-26 at 10.58.51 AMNow you can begin to see why I hypothesized two stages in the Great Moderation. The five business cycles during the Truman/Eisenhower years saw especially volatile IP.  Most strikingly, the smallest peak of those 5 cycles (my birth year) is higher than the highest peak since 1960.  On the IP graph it looks like the Great Moderation began in 1961, and then got even more moderate after 1984.  So that made me wonder why other researchers don’t point to 1961 as the turning point.

Go back to the real GDP graph, and you’ll see why.  The moderation in real GDP during the Kennedy through early Reagan years (say 1961-84) is much less pronounced than for IP.  Not really statistically significant.

We’ve looked at IP, so what’s left?  Most of what’s left is consumption—was that becoming more volatile during 1961-84, offsetting the improvement in IP stability?

Screen Shot 2015-10-26 at 11.05.22 AMNot as far as I can tell. Indeed if it weren’t for the two severe oil shocks (1974 and 1980) consumption might well have become less volatile after 1961.  If those two oil shocks had occurred in the Truman/Eisenhower years, and not during 1961-84, then perhaps the Great Moderation would have been dated from 1961.

But we still have a mystery to explain.  The reduced volatility in IP after 1961 is quite clear, whereas consumption is about the same, or perhaps slightly less volatile.  So why doesn’t the real GDP graph show more improvement?  After all, consumption and IP are most of the economy (and yes I know I’m double counting a bit here, but my question remains.)

One thing that’s left is construction.  I could not find a real construction series going back that far, but did find residential investment:

Screen Shot 2015-10-26 at 11.10.58 AMNow we are getting somewhere!  Notice that residential investment is actually more volatile during 1966 to 1984 that during the preceding 14 years.  Yes, home building is a modest share of GDP, but look at the swings in those growth rates.  (I could only find nominal growth, but the swings are so large that they’d also show up in real growth.)

So now we seem to have a partial answer.  There was some tendency for the economy to moderate after 1961, but mostly if you exclude homebuilding.  If you include homebuilding, then 1984 looks like the year that the Great Moderation began.  The question is why?

Here’s the graph you have all been waiting for, monetary policy (er, I mean NGDP growth.)

Screen Shot 2015-10-26 at 11.16.12 AMNGDP growth volatility clearly fell after 1961, and then moderated further after 1984 (except for 2008-09, obviously.)

So why didn’t RGDP growth moderate as much as NGDP growth, during the 1961-84 period?  The easy answer is the two oil shocks.  (And I’d add the imposition and removal of price controls in 1971-75.)  Yes, that may be part of the story; the oil shocks hit consumption hard.  But let’s think about residential investment, which became more volatile during the middle period.  Why did that occur when NGDP growth was becoming more stable?

The answer seems clear, NGDP growth from one year to the next was becoming more stable, but the longer-term NGDP growth rate was becoming unanchored, as inflation soared from 1% to 13%.  With trend NGDP growth changing significantly, and unexpectedly, long-term nominal interest rates (on T-bonds and fixed rate mortgages) became highly unstable.  Yields on 30-year T-bills soared to roughly 15% in 1981.

Because of our peculiar residential mortgage system, these big swings in interest rates whipsawed residential investment, making it highly volatile during the Great Inflation. That’s why the Great Inflation had to end before the Great Moderation could begin.  It also implies that if the Great Inflation had been steady inflation/NGDP growth, which was predictable, then the Great Moderation would have begun in 1961, not 1984.  (And if my grandmother had wings . . . )

In this story there are two key milestones:

1. In 1961 the Fed figured out how to avoid the stop-go policies of the previous 15 years. But their technique left longer-term inflation/NGDP growth completely unanchored. After 1984 the Fed figured out how to walk and chew gum at the same time, how to keep inflation both low and stable.  Ditto for NGDP growth (except 2008-09)

If you look closely at the residential investment graph, you’ll see that homebuilding was more volatile in the 1990-91 recession than in the 2001 recession.  That may be because in the first of the two we were still working off the last bit of the Great Inflation. Inflation went into that recession at a 4.5% rate, and came out closer to 2%. In the 2001 recession we entered and left the recession with about the same (2%) inflation rate.  Of course there were other factors too, the 2001 recession was focused on business investment, and the resulting fall in interest rates helped homebuilding.  In 1990, homebuilding had been overextended by reckless S&L lending.  But even with all the craziness in homebuilding in the past few decades, the 1970s were even more unstable.

Obviously the Great Recession is sui generis (first time I’ve used that term), but in the recovery period we are back to eerily steady RGDP growth.  The 5 recessions in 15 years that we saw after WWII now seems like ancient history.  I can’t even imagine the US having 5 recessions in the next 15 years—although the one thing I’ve learned in macro is that just when you expect something will never return (like zero interest rates) it comes back.  So all forecasts are provisional.

PS.  IP involves domestic capital goods, domestic consumer goods and exports. The domestic consumer goods portion is double-counted in my analysis.  It might have been better to use services rather than consumption—but I doubt my conclusions would have changed.

You need to act right now! (Because we are too timid.)

From the Wall Street Journal:

For an institution that jealously guards its independence, the Federal Reserve is wading into treacherous political waters.

With the economic rebound still mediocre at best, the Fed is charging into the housing debate. But in doing so, it runs the risk of politicizing itself, while also sending mixed signals to banks still trying to find their postcrisis feet.

The latest effort was a housing “white paper” sent this week to Congress, along with a series of comments from Fed officials about the importance of housing to the economic recovery. In this, the Fed may be laying the groundwork for further quantitative easing, this time purchasing mortgage securities. But its paper went beyond even the Fed’s already unconventional policies. This included ideas that might require more taxpayer funding through Fannie Mae and Freddie Mac.

But having broached the thorny issue of using government entities to boost housing, the Fed didn’t touch on questions surrounding a needed long-term revamp of housing finance. This left the Fed implicitly endorsing the housing status quo: a market that is almost completely dependent on the government and, in particular, Fannie and Freddie. Whether the government should be involved in housing, or to what degree, is of course a highly contentious political question for Congress.

The Fed’s paper suggested it may be worth pursuing more aggressive actions in terms of loan modifications, mortgage refinancing and sales of foreclosed properties even if they cause greater short-term losses at Fannie and Freddie, and so by extension to taxpayers. And the paper may have led some in markets to believe a new, government housing effort was coming. The Fed’s paper said a possible policy option would be for the government to expand existing refinancing efforts “or introduce a new program.”

About those 4 million jobs

I see that Joe Gagnon’s new housing plan has garnered attention from Paul Krugman and Matt Yglesias.   You might wonder why I call it Gagnon’s plan, not Obama’s plan.  Here’s why:

Even more important, if the Federal Reserve supported the refinancing boom by purchasing $2 trillion of new MBS, for example, the existing MBS holders would have to find another market in which to invest $2 trillion. This avalanche of money would surely push up stock prices, push down bond yields, support real estate prices, and push up the value of foreign currencies. All of these financial developments would stimulate US economic activity. Based on a recent Fed study (Chung et al 2011) Fed purchases of this magnitude would increase US GDP by more than 2 percent after about two years, creating nearly 3 million additional jobs. This estimate includes only a small part of the effects operating through the mortgage refinance channel discussed above, so that the total effects on the economy would be even larger, perhaps creating 4 million extra jobs or more.

A few comments:

1.  I don’t want to get into any “how many angels . . .” arguments here.  The plan contemplates massive open market purchases by the Federal Reserve.  I’d call that “monetary policy,” you are free to call it whatever you like.  Whatever you call it, the decision is up to Bernanke, not Obama.

2.  My hunch is that the housing refinance angle wouldn’t create many jobs.  I say “hunch” because I’m not really qualified to judge.

3.  As you know I am a big fan of Gagnon, so this post shouldn’t be viewed as criticism.  I would strongly support a $2 trillion OMP.  I don’t really have any idea how many jobs it would create, but it would be worth a shot.

America’s rich because we have lots of big houses

Why do so many immigrants want to come to America?  Not because we have great infrastructure; I’ve seen better in many foreign countries.  Instead, it’s our high level of consumption.  And what makes our consumption so high?

Think about the basic necessities; food, clothing and shelter.  For several decades, almost all developed countries have met the needs of most citizens for food and clothing.   We can only eat so much, and elegant clothing has gone out of fashion.  Go to a football game and you might be sitting next to a millionaire or a plumber.  There’s no way to tell because either could be wearing blue jeans.  Indeed the plumber may well be a millionaire.

Houses are different.  People really like big houses in nice locations.  And that’s where America really shines.  When immigrants from Mexico or India or China see how much house you can buy in a Houston suburb for $350,000, they are blown away.  And not just a big house, but room to park your cars and boats.  All within the price range of a professional, upper middle-class salary.

This post was triggered by a very interesting Karl Smith post, which showed that about half of our entire capital stock is housing and home improvements:

Now this only includes private capital so roads and other government infrastructure are not in there. However, you can see that its overwhelmingly housing, then shopping.

So when you say, increase the size of the US capital stock to large extent what we mean are bigger and better homes and shopping centers.

And when we say increase the productivity of workers what we mean is that homeowners get more out of being their own landlords and that retail workers are serving customers in nicer facilities.

Matt Yglesias is a bit skeptical:

I’d say it’s a reminder that you need to treat government statistical categories with a grain of salt. The “residential investment” category should probably be thought of as a form of consumption. But that means it’s important to ask, when faced with a tax policy concept that’s allegedly pro-growth due to its investment properties, whether it’s not just really a proposal to shift consumption out of some sectors and into housing.

I can’t imagine how this could be right.  I admit that the line between consumption and investment is blurry.  But the borderline cases are things like cars and home appliances, not houses.  The longer an asset lasts, the more capital-like it is.  And well built houses last for a long time.  Admittedly I may be biased, as I live in a town full of old, well-built houses.  And in cities like Detroit lots of homes are being torn down.  But I don’t think Newton is that exceptional.  I visit Tucson every year, and see the sorts of new homes that are much more typical of 21st century America.  And the Tucson homes that sell for about $200,000 are clearly built to last for 100 years with little maintenance.  These are certainly “capital” by any reasonable definition.  Indeed many factories and other commercial structures become obsolete long before houses do.  The houses I lived in as a kid (in Wisconsin) were already very old.  Yet none have been torn down.  In contrast, sports stadiums built in the 1970s that I recall as new and futuristic, are already obsolete.

I often notice commenters who share Yglesias’s attitude toward houses, and sometimes I wonder if it represents a sort of prejudice.  We’ve all seen people who think that German export of cars or turbines is somehow more virtuous than Greece’s provision of tourism services, or London’s provision of advertising services.  Perhaps the attitude toward housing is somehow related to this deep-seated belief that some products are more worthy than others.  I’m not opposed to Veblen-like cynics arguing that the pleasure derived from a big house is shallow and superficial.  (Easy to do if you aren’t a Chinese or Indian immigrant who grew up 5 people to a room.)   But the same is true for most of the stuff churned out by our factories.  And no one denies that factories are “capital.”

PS.  I favor abolition of the tax deduction for mortgage interest.  And a minimum 20% down payment for any mortgage from a FDIC-insured institution.  And a carbon tax.  I like big houses, but not enough to subsidize them.

Housing, the CPI, and real wages

At times like these I’m glad I’m not in Paul Krugman’s shoes.  Here Krugman discusses the fact that inflation isn’t declining, even though NK models say it should decline when there’s lots of slack in the economy:

That said, is inflation running higher than I expected? Yes. Am I worried that this might be the beginning of a runaway inflation process? No. Do I sound like Donald Rumsfeld? Yes.

The IMF study of PLOGs “” prolonged large output gaps “” pretty much summarizes my own views. You expect a persistently depressed economy to have falling inflation, although it tends to level out at a small positive number. There can be episodes of rising inflation along the way, however, but these normally reflect special and temporary factors, usually oil prices and/or currency devaluation.

US experience mostly fits this pattern, although I now believe that there’s an additional special factor that isn’t typical: the prolonged slump in home construction has now created a bit of a shortage, so rents are rising “” and since implicit owners’ rent is a major part of core inflation, that’s causing a pickup over and above the effects of oil prices.

Sometimes people ask me why I focus on NGDP, rather than RGDP and inflation, like a normal economist.  From the beginning I’ve been arguing that inflation is a pretty meaningless number, or at least it doesn’t mean what we tend to assume it means–the change in the price of goods and services produced by American labor.  Most economists understand the imported oil bias, but housing is a much larger share of the CPI (roughly 1/3, and even higher for the core.)

Question:  What’s happened to American housing prices over the past 5 years?

Answer:  According to Case-Shiller they’ve fallen by 31.6%.

Question:  And what’s happened to housing construction over the past 10 years?

Answer:  According to this graph provided by Matt Yglesias, housing construction has been unusually low during the past 10 years, when compared to previous decades.

That sounds a lot like an adverse demand shock.  Yet many continue to insist we built too many homes, even though that would lead to quantity and prices moving in the opposite directions, not the same direction (never reason from a price change.)

So why is housing causing a problem for the Krugman model?  The answer is simple; the BLS doesn’t agree with Case-Shiller, they don’t agree that house prices fell 31.6%.  What kind of figure did the BLS come up with?

Answer:  7.7%

I can just imagine your reaction:  “What!?!?!?!?!  They claim housing costs only fell 7.7% over the past 5 years!  That’s insane.”

I’m afraid you’d better sit down for this.  The BLS doesn’t claim housing prices fell 7.7% since mid-2006, they claim they rose by 7.7%.  Just a minor 39.3% discrepancy with C-S.

Now I’m sure people will tell me that the BLS uses a different methodology.  They look at rental equivalent.  But that’s still a pretty big discrepancy.

Now let’s consider an argument frequently made by commenters; real wages are falling, whereas my sticky wage model (supposedly) predicts they should be rising.  (Actually it doesn’t.)   Consider two brothers, one who graduates from high school in 2006 and makes $40,000.  He buys a house for $150,000.  The younger brother graduates in 2011 and makes $43,000.  He buys a similar house for $100,000.  Who’s better off?  The BLS says the older brother, because real wages have fallen.  And that’s because the cost of living rose by more than the wage rate.  But whose shoes would you rather be in?

Now it’s quite possible that the younger generation is worse off than 5 years ago.  But not because real wages are falling, rather because they have worse jobs, fewer hours, or are completely unemployed.

The problem with new Keynesian economists is that they believe the government data for inflation, real wages, etc, actually measures the theoretical concepts that the model tries to address.  But they don’t.  Even NGDP is far from perfect, but at least it’s not as distorted as the CPI.

PS.  By the way, the minimum wage has increased 40% since 2006.

PPS.  Even the C-S index isn’t the theoretically appropriate price of housing, as it includes land.  We’d like to know the change in the price of stuff actually built with US labor, and land isn’t built.  Nor is “rental equivalents.”

PPPS.  Someone sent me a chart showing that 10 year TIPS spreads in Europe have fallen to 0.6%.  Can one of my European readers confirm this stunning data point?  Thanks.