The U.S. economy has recovered slowly since the official end of the Great Recession in 2009. Mark Lasky and Charles Whalen of the Congressional Budget Office just released a study asking why. Their answer: two-thirds of the slowness (relative to past recoveries) reflects weak growth in the economy’s potential. The potential labor force, capital stock, and productivity are all growing less rapidly than they did following past recessions. The other third reflects cyclical weakness, particularly in government, housing, and consumer spending.
CBO’s Maureen Costantino and Jonathan Schwabish turned those results into a nifty infographic (click to make larger):
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Many economists, myself included, refer to the recent boom and bust in house prices as a bubble, whose foundation lay in a combination of credit market excesses and human imperfections. Fundamentals certainly played a role as well, but bubble forces were particularly important.
In a short paper recently published by the New York Federal Reserve, Jim Kahn makes a very different argument: that the boom and bust in house prices can largely be explained by a boom and bust in productivity growth:
The housing boom and bust of the last decade, often attributed to “bubbles” and credit market irregularities, may owe much to shifts in economic fundamentals. A resurgence in productivity that began in the mid-1990s contributed to a sense of optimism about future income that likely encouraged many consumers to pay high prices for housing. The optimism continued until 2007, when accumulating evidence of a slowdown in productivity helped dash expectations of further income growth and stifle the boom in residential real estate.
Jim’s argument depends on several related lines of reasoning:
- First, he notes that productivity drives long-term income growth and that incomes determine how much families can pay for homes. He then argues that the demand and supply for housing are inelastic and, as a result, rising incomes imply rising house prices. Putting these pieces together, he concludes that faster productivity growth implies faster house price appreciation.
- Second, he notes that productivity growth accelerated in the mid-to-late 1990s and then slowed around 2004. The productivity acceleration thus began shortly before house price took off, and the productivity slowdown began shortly before house prices began to collapse.
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