Tuesday, March 24, 2009

Housing is not the business cycle

There is a widespread belief that the housing market is closely linked to the business cycle. In particular, housing starts are a major component of the leading indicator index, meaning that housing start statistics tends to precede whatever happens to the business cycle. This belief is grounded on the analysis of national data. What about the local level?

Andra Ghent and Michael Owyang compare permits issued with labor market data in 26 US metropolitan areas. They find, after controlling for national effects, that the local housing markets are very poor predictors for local labor markets. The critical aspect here is to control for interest rates.

I learn from this that housing as a leading indicator should be considered with a grain of salt. But it is not quite clear to me what this means in terms of our understanding of the economy. The measure here is the number of permits issued. Is the reason this does not explain subsequent labor market outcomes that fluctuations in interest rates are really driving the execution of those permits, and thus the labor market?


Andra said...

Someone else brought up this concern earlier and so we looked it into it. We don’t think it’s likely that what is happening is that there is a big difference between permits and actual execution on those permits. Here’s what the Census Bureau had to say about the matter:
"Current surveys indicate that construction is undertaken for all but a very small percentage of housing units authorized by building permits. A major portion typically get under way during the month of permit issuance and most of the remainder begin within the three following months. "

Edward J. Dodson said...

Use of the term "housing" market causes analytical problems. Most housing is not inventory in the same way other goods offered for sale are inventory. New construction adds only marginally to the supply of housing units, and in many markets does not even replace the number of housing units no longer habitable because of depreciation and abandonment.

More importantly, the real driver of property markets, generally, is essentially ignored by most economists. This driver is land markets, which are not responsive to price changes in the same way as are the markets for labor, capital goods and credit. The reason for this should be obvious. The supply of locations in essentially inelastic. Net imputed rental income streams are capitalized by market forces into higher and higher selling prices for locations, which rewards withholding of supply for speculative gain. Supply of affordable locations increases only when skyrocketed land prices have put such stress on business profit margins or the ability of households to afford residential property. For a period thereafter, business and individual bankruptcies result in large numbers of bank foreclosures. When, as in the curent economic crisis, business closings and loss of employment are widespread, a domino effect is created.

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