Housing's Role in a Recovery

Abstract

T hree years ago an article1 in this publication discussed the relationship between housing and the “R” word—“R” meaning recession, a term no one wanted to use (lest they jinx the economy) but nevertheless were thinking about. Now, after the worst recession since the Great Depression, we consider a different “R” word—recovery. The fact that many of the same concerns in the housing market remain raises this question: How important is housing in an economic recovery? Somewhat surprisingly, the housing component of GDP (more formally known as residential investment) tends to be a solid contributor to GDP growth during a recovery. Historically, residential investment has contributed only about 5 percent of GDP—a small share considering the consumption component is close to 70 percent. Neverthe less, smaller components such as residential investment do at times punch above their weight, which is evident when their effects are measured using growth rates rather than levels. That is, although residential investment is a small component of GDP in levels, it can contribute substantially to the GDP growth rate for short periods of time. The chart illustrates the relationship between residential investment and the business cycle over the past 35 years. It plots the rolling 4-quarter percentage contribution of residential investment to GDP growth. Over the period, residential investment contributed on average a meager 3 basis points to GDP growth. In contrast, excluding the recent recession, residential investment typically contributes at least 50 basis points to GDP growth within two years following a recession. This suggests that, although residential investment is not a major component of GDP growth on average, its growth typically helps during an economic recovery. However, a year and a half after the official end of the recent recession, residential investment has yet to make a sizable contribution to GDP growth and is, in fact, presently making a negative contribution. To some degree this should be expected. The dramatic declines in housing prices during the recession created a glut of existing homes either already on or waiting to be put on the market once prices stabilize and start increasing. This “shadow inventory” of existing homes substantially dampens the need for new home construction.