The Room for Debate asks:
Can the economy recover without a turn-around in home sales? Many say that job improvement has to come first, but the bad news on housing sales has put a new gloom on expectations of a recovery. Does the housing market have to lead the way out of the hole? If so, why?
The 800 word version of my response is below, but if you prefer, the edited, less wordy 400 word version, it is here along with responses from Jennifer H. Lee, Jeffrey Frankel, Patrick Newport, and Dean Baker [all responses]. Among other things, I wish I'd talked more about employment:
The bad news for recovery seems to be nonstop lately, with new home sales, which were at a record low in July, and durable goods orders, which came in far below expectations, continuing the trend. What does this say about the prospects for recovery?
It’s useful to break down the economy into four major sectors — households, businesses, government, and the foreign sector — and consider how each will affect both long-run and short-run prospects for growth.
Household consumption, which excludes the purchase of new homes (more on this in a moment), is unlikely to be the engine of growth that it has been in recent decades. Consumption before the crash was largely debt fueled, based on the false promise of continuously rise housing prices, and therefore unsustainable.
It’s widely believed that consumers will move to a lower level of consumption and a higher level of savings after the recession. During this transition, lower consumption growth will be a substantial drag on the economy — this would be on top of the decline in consumption caused by the recession itself. So while growth may return to normal in the long-run, it’s unlikely that this sector will lead the way to recovery.
If consumption by households isn’t the answer, what about investment? In the national income accounts, the purchase of new homes is counted as part of investment. Can investment by businesses or home purchases pick up the slack?
While housing will some day grow normally again, the large excess inventory of homes, poor sales, and other problems right now means that day is far, far away. In the short-run, looking to housing to lead the recovery is likely to lead to disappointment.
Business investment does not provide much hope either (the weak report durable goods orders on Wednesday is no comfort). Business investment might pick up some once there are signs of improvement in the economy, and if the Fed lowers long-term interest rates through quantitative easing, but this sector will follow the expectation of better times, it won’t lead them.
As for foreign exports, which is one of our best hopes for growth in the long-run, it hard to see that sector leading the recovery since the rest of the world is having troubles too.
So there’s very little besides government that can provide the needed boost to the economy in the immediate future. If government can provide the bridge across our short-run problems, then the other sectors can take over and generate long-run growth, and the hope is that the growth will be as robust as before the recent crash. But there’s no guarantee that hope will be realized.