Tuesday, April 9, 2013

The construction sector is key to the business cycle

It is well known that the construction sector is a very important indicator of the business cycle. In fact, residential construction has been a reliable early indicator of economic activity for many decades and this characteristic is occasionally rediscovered. What is there still to learn about the construction sector?

Michele Boldrin, Carlos Garriga, Adrian Peralta-Alva and Juan Sánchez build a business cycle model including an input-output table. Looking at the last business cycle and putting in the model only variations in housing demand, they find that the construction sector contributed to 30-60% of the increase of employment before the recession, and 8-15% for GDP. But during the recession, the importance of this sector was even more massive: 30-40% respectively 45-60%. Part of it comes from the size of the shock, and part for the inter-linkages with other sectors.

Now think about the consequences for policy: if a major part of the recession of the recession is driven by a single and relatively small sector, it makes no sense to rely solely on monetary policy as it is currently the case. Monetary policy cannot distinguish by sector (and if it does, it loses independence). One would need active fiscal policy, like what was initially intended with the stimulus program. The current austerity mood, however, goes exactly in the other direction, as public investment programs are of course the first ones to suffer from cuts. Or you can just declare that this is all a structural shift, and keep any policy out of this.

1 comment:

Milton Recht said...

A better policy would be to find a way to decrease the over reliance on the single sector of construction, while increasing the positive economic effects of other sectors.

How can the US speed up structural shifts to avoid long term economic slowdowns when a previous growth sector is declining?