Sunday, September 9, 2007

Anatomy of a Recession (Ed Leamer at Jackson Hole)

This year's Jackson Hole Symposium was on Housing, Housing Finance, and Monetary Policy. If you're interested in learning more about the current subprime mess, the symposium proceedings are a good place to start.

Ed Leamer, from UCLA, presented a paper on Housing and the Business Cycle (pdf). It's well worth reading in detail. He gives a very thorough and readable analysis of the last 10 recessions, detailing how recessions start (a downturn in residential housing investment, not housing prices), how they spread (weakness in consumer spending first on durables, then non-durables, then services, but not business spending), how they deepen once they've started (a fall in business investment in equipment, software and inventories), and finally how the end: housing investment recovers, then consumer spending recovers, and lastly business spending recovers. Eight of the last ten recessions fit this mold; 1953 and 2001 were the two exceptions.

The recovery is aided by cuts in the Fed funds rate, which disproportionately stimulate housing demand and which have historically signaled the beginning of the end of a recession. This time, however, the Fed's already used up those bullets during its last round of cuts in 2001-2003.
With the huge housing inventory overhang, there's no more housing investment left to stimulate. So if consumer spending starts to fall, interest rate cuts by the Fed might support housing prices by making mortgage finance cheaper, but housing investment isn't going to recover in the way that has typically been required to end a recession. So a consumer recession could be long-lasting.

The paper is long (73 pages), but lots of graphs and his conversational writing style make it easy reading.

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