Economic recovery is different this time

The role of housing in the economic recovery was addressed in a presentation by Eric Rosengren, president and CEO of the Federal Reserve Bank of Boston in January. Rosengren’s speech highlighted two questions associated with the economic future of the nation.

Thursday, March 10, 2011
By Austin Jaffe, Ph.D.

The role of housing in the economic recovery was addressed in a presentation by Eric Rosengren, president and CEO of the Federal Reserve Bank of Boston in January. Rosengren’s speech highlighted two questions associated with the economic future of the nation.

Like others, Rosengren is more optimistic about economic growth for 2011 these days than in the recent past.  He predicts a 3.5 – 4 percent growth rate with continuing low interest rates due to low inflationary expectations and a stimulative Fed policy. However, like most other observers, he does not expect unemployment to dip below 9 percent even by year end. (In fact, he estimates that it will take as long as four years to return to a full employment economy!)

Traditionally, housing has played an important role in leading the economy to recovery.  However, this time, the state of housing markets is such that it is less important and less supportive as a sector. He states, “my sense is that residential investment, consumer durables, and services related to housing will be less robust than is usual in many recoveries, thus playing a role in what I think will be only a gradual improvement in the economy and employment.” In effect, with a weak housing recovery, this sector will limit economic growth leading to an extended period of high unemployment.

Housing is important to the macro economy but the situation is different this time. The decline of housing markets around the country has led to a slowdown in consumer durable purchases (e.g., kitchen appliances, new furniture and so on). It has also reduced the demand for housing-related services. Rosengren points out that there are no real signs of recovery in the housing sector, although the overall economy has been improving since the second half of 2009. This development is good news for many in the country but not so good for members of the real estate profession.
Much has been made of the importance of the consumer in the U.S. economy, accounting for about 70 percent of the demand. The bursting of the housing bubble has stymied consumer demand overall. There is a difference between the 2001 recession and the current period in this regard. In 2001, consumers experienced a significant decline in their household wealth due to reductions in equity values in the stock market. In the current recession, households were hit both in equity holdings as well as in lower home prices. Recent days have witnessed a return of stock prices to higher levels of two years ago; there have been no such parallel moves in house prices.

Without much inflationary pressure appearing in markets, mortgage rates remain low, although there is some indication of slight increases in recent days. The Fed appears determined to provide plenty of liquidity, despite significant criticism of QE II, so mortgage financing may remain readily available. That is, credit will be offered for those with very good-to-excellent credit rating scores.

Rosengren concludes that housing remains “fragile” despite many efforts to support this sector by various government programs. This time, housing will not lead the economic recovery. Further, there is a growing recognition that the continuing foreclosure saga is causing a drag on the overall economy. It is different this time but eventually housing will stabilize and the recovery process will begin in earnest.

Austin Jaffe, Ph.D. is PAR's Consulting Economist from the Smeal College of Business at Penn State University.