By Karl Smith
As per usual I am going to co-sign something that Matt Yglesias wrote.
I don’t exactly want to "defend" the Federal Reserve from the scorn that’s been heaped on it after the release of the 2006 FOMC transcripts, but it is worth paying attention to the timing. . . .
[Residential Construction] enters negative territory in the last quarter of 2005. Then it stays negative all four quarters of 2006, and during all this time the FOMC members are makign statements about how the economy should survive the housing bust. Then it’s negative for four more quarters throughout 2007. And then for the first two quarters of 2008. And all that time from the latter part of 2005 through all of 2006 and 2007 and through the beginning part of 2008, the Federal Reserve is basically doing its job correctly.
Watching at the time it was clear that the US Housing Bubble Burst, the 2008 recession and the Global Financial Crisis three related but definitely distinct things.
Indeed, here is Private Fixed Residential Investment over the boom and bust. Its not my favorite indicator but its denominated similar to what I am going to compare it to. We get a familiar picture.
Now I am going to layer over-top of that the inverse of net exports. Which is in fact net imports, and subtracts from GDP.
And, here is the two summed together for the net contribution to GDP growth.
You can see that by the time the recession hit the Housing-Export complex was actually adding to growth.
Now, why is this an important complex to look at?
Because, as many commenters have noted the boom in residential construction was in large part financed by large external deficit. We borrowed money from the Chinese (and Germans and Japanese) to build a bunch of homes in the United States.
However, the way you borrow money from other countries is by running a trade deficit. As residential construction shrank, so did the trade deficit. This provided the economic offset that kept the economy from going into recession in 2005 as residential construction rolled over.
By the beginning of 2008 though other sectors of the economy – notably non-residential construction and manufacturing, were beginning to weaken. This tipped the economy into recession.
Here is nonresdential fixed investment, a category that includes both nonresidential construction and equipment and software, plotting along with the sum of durable and non-durable goods consumption.
Both turned downward in late 2007 which brought on the recession proper in 2008.
Both the consumption of services and the government sector peaked after the recession began.
The growth in both is so strong its hard to see the change, so this is a zoom in.
You can see the both kinking in the 3rd quarter of 2008. Government goes from slow to an outright fall. Services goes into a much faster fall which it sustains into 2009. That’s the Global Financial Crisis.
We only have real service data going back to 1995 but we can see how different the service and government sector response was this time around as opposed to dot-com.
In the 2001 recession the hit to government and services is barely noticeable where in this recession there has been essentially stagnation since the middle of 2008.
And, the two sectors together are quite large, accounting for about 2/3rds of GDP.
So, we can see the three events, residential construction collapse, recession proper and Global Financial Crisis all as distinct events.