Housing Starts Forecast of Retail Sales through the 2007-2009 Recession

Abstract

The expansion following the 2001 recession was in part stimulated by a boom in housing market investments. Many economists were concerned that a severe drop in residential investments would cause a recession throughout the economy because of residential investment's relationship to the gross domestic product and financial markets, and that a decline in housing prices would negatively impact consumer spending. A severe decline in the housing market and the illiquidity in the financial market were both evident by the third quarter of 2007. Some models based on historical data were showing the certainty of a recession in 2007. The best predictors of recessions are respectively interest rate spread, unemployment claims, and building permits. Building permits/new private housing units are a leading economic indicator whereas retail sales are a component of manufacturing and trade sales, which is a coincident economic indicator because it is highly correlated to GDP. This study attempts to use housing starts and past values of retail sales to forecast out-of-sample retail sales values through the period of January 1998 to August 2010, which is inclusive of the recent 2007-2009 recession. If housing Starts are found to be predictive of retail sales, then they are a predictor of a coincident indicator of recessions. This forecast is done in the framework of neural network modeling referenced to robust regression analysis. It was expected that the neural network models would produce better forecasts as ascertained by correlation, root mean square error, and Theil inequality coefficient performance metrics, but the overall result was mixed.