Housing IS the Business Cycle

by: Barry Ritholtz

I seem to get the question all the time. What's with all the Housing stuff? I thought you wrote about the economy and the markets? Readers ask it, colleagues question it, Larry the K used to tease me about it all the time.

There is a damned good reason. But rather than give you a long diatribe, I will point you towards some recent research from Professor Edward Leamer of the Graduate School of Management at UCLA.

Now, I have frequently disagreed with Dr. Leamer on a variety of issues: I found his take on privatizing Social Security misunderstanding the concept of insurance, and his algorithms for forecasting recessions miss many subtleties of economic contractions.

However, the professor's take on the significance of Housing to the business cycle -- including recessions and recoveries -- is dead on.

According to Leamer, HOUSING IS THE BUSINESS CYCLE. And, he has charts ans graphs to prove it.


Of the components of GDP, residential investment offers by far the best early warning sign of an oncoming recession. Since World War II we have had eight recessions preceded by substantial problems in housing and consumer durables.  Housing did not give an early warning of the Department of Defense Downturn after the Korean Armistice in 1953 or the Internet Comeuppance in 2001, nor should it have.

By virtue of its prominence in our recessions, it makes sense for housing to play a prominent role in the conduct of monetary policy.  A modified Taylor Rule would depend on a long-term measure of inflation having little to do with the phase in the cycle, and, in place of Taylor's output gap, housing starts and the change in housing starts, which together form the best forward-looking indicator of the cycle of which I am aware. This would create pre-emptive anti-inflation policy in the middle of the expansions when housing is not so sensitive to interest rates, making it less likely that anti-inflation policies would be needed near the ends of expansions when housing is very interest rate sensitive, thus making our recessions less frequent and/or less severe.

Fascinating stuff.

Some charts add to the analysis:

Residential Investment: Cumulative Abnormal Contribution to GDP Growth



Weakness of Residential Investment Before Recessions

Contribution to Weakness in GDP, The Year Before the Recession
Graphs courtesy of Edward Leamer, NBER Working Paper 13428

Edward E. Leamer
Working Paper 13428

Download HOUSING IS THE BUSINESS CYCLE  (83588-w13428) .pdf