Why So Much Housing? Hint: Its the Business Cycle

I seem to get that question all the time. What’s with all the Housing stuff? I thought you wrote about the economy and the markets? Readers ask it, colleagues question it, Larry the K used to tease about it all the time.

There is a damned good reason. Rather than give you a long diatribe, I will point you towards some recent research from Professor Edward Leamer of the Graduate School of Management at UCLA.

Now, I have frequently disagreed with Dr. Leamer on a variety of issues: I found his take on privatizing Social Security misunderstanding the concept of insurance, and his algorithms for forecasting recessions miss many subtleties of economic contractions.

However, the professor’s take on the significance of Housing to the business cycle — including recessions and recoveries — is dead on.

According to Leamer, HOUSING IS THE BUSINESS CYCLE. And, he has charts ans graphs to prove it.


Of the components of GDP, residential investment offers by far the best early warning sign of an oncoming recession. Since World War II we have had eight recessions preceded by substantial problems in housing and consumer durables.  Housing did not give an early warning of the Department of Defense Downturn after the Korean Armistice in 1953 or the Internet Comeuppance in 2001, nor should it have.

By virtue of its prominence in our recessions, it makes sense for housing to play a prominent role in the conduct of monetary policy.  A modified Taylor Rule would depend on a long-term measure of inflation having little to do with the phase in the cycle, and, in place of Taylor’s output gap, housing starts and the change in housing starts, which together form the best forward-looking indicator of the cycle of which I am aware. This would create pre-emptive anti-inflation policy in the middle of the expansions when housing is not so sensitive to interest rates, making it less likely that anti-inflation policies would be needed near the ends of expansions when housing is very interest rate sensitive, thus making our recessions less frequent and/or less severe.

Fascinating stuff.

Some charts add to the analysis:

Residential Investment: Cumulative Abnormal Contribution to GDP Growth


Weakness of Residential Investment Before Recessions

Contribution to Weakness in GDP, The Year Before the Recession

Graphs courtesy of Edward Leamer, NBER Working Paper 13428


Edward E. Leamer
Working Paper 13428

Download HOUSING IS THE BUSINESS CYCLE  (83588-w13428) .pdf

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What's been said:

Discussions found on the web:
  1. berkshire commented on Aug 21

    You continue to put excellent information on all kinds of topics into well thought out, easy to read posts. I am (and have been), and continue to be, very impressed. Keep up the good work.



  2. bob commented on Aug 21

    Hmm, this is typical MBA/banking type “research”: pretty charts, spurious correlations etc. but it doesn’t get to WHY (in the post title) the housing sector can drag the whole economy into recession.

  3. tyaresun commented on Aug 21

    And yet, he is saying that we will not have a recession this time. If we are to believe this paper we are already in a recession.

  4. Scott in Chicago commented on Aug 21

    Nice chartage, Barry. And if Kudlow mocks or teases that, too, is a good sign you are on the right track. The Laffer, Kemp, Kudlow model is a fraud and a failure. The Milton Friedman fetishist belong in rocking chairs on a porch, yelling at kids and passing cars that lower taxes fix everything, all government regs are bad, and to keep off the lawn. What a scam.

  5. Charley commented on Aug 21

    Perhaps the importance of housing in the business cycle is growing because our manufacturing base continues to shrink.

  6. Charley commented on Aug 21

    Perhaps the importance of housing in the business cycle is growing because our manufacturing base continues to shrink.

  7. Paul Habibi commented on Aug 21

    Long time reader, first time contributor…

    Dr. Leamer is right on in his analysis. While I should disclose that I am a member of the real estate faculty at UCLA, I’d like to point out some corroborating insights from our colleague Prof. Stuart Gabriel a few months back. To paraphrase Gabriel, “real estate is the tail that wags the dog” as it relates to the economy. Real estate is about 4% of GDP but has the ability to literally lead the entirety of the US, if not the global, economy if into an economic downturn. The housing sector is cyclically sensitive, and sensitive to monetary policy and Federal Reserve activity. Housing has backward and forward linkages into construction, building materials, home furnishings, and so forth, as such, reaches its tentacles deep into the rest of the economy. So despite its limited absolute size, it can lead the econony into and out of, an economic downturn.

    Here’s the link to the actual webcast:


    This all might seem quite obvious, but often times it’s the obvious that gets overlooked while we’re busy reaching for a more complex level of understanding.

    Paul Habibi
    Lecturer, UCLA Anderson School of Management
    Principal, Habibi Properties

  8. J.E commented on Aug 22

    First contribution too; thanks Barry for your excellent blog, I’ve been reading it since August 2006. I hope this will interest you.

    Find below a very interesting paper on the links between the real-estate cycle and business cycle – with a theory that makes sense:

    Real Estate and Business Cycles: Henry George’s Theory of the Trade Cycle
    by Fred E. Foldvary, Latvia University of Agriculture, Presented at the Lafayette College Henry George Conference, June 13, 1991

    Great Britain’s real estate cycles started as early as the close of the 1700s, when land values rose. Between 1842 and 1914, in 22 of the 26 peaks and troughs of the business cycle, house building preceded or coincided with the turning points in business (Harrison, 1983, p. 73).

    Karl Pribam (1940, p. 65) reports that pre-World-War-I construction in Great Britain and Germany anticipated business contraction or expansion by one to three years.

    The United States has had a real estate cycle of roughly 18-year spans, starting as early as 1800. The peaks of the U.S. real estate cycles from 1800 to 1960 occurred in 1818, 1836, 1854, 1872, 1890, 1907, and 1925. Cycle bottoms occurred in 1819, 1843, 1858, 1875, 1894, 1908, and 1933 (Hoyt, 1970, p. 537). Upward movement in real estate prices persisted in 1819-1836, 1860-72, 1894-1907, 1908-1925. Sharply falling real estate prices occurred in 1818-19, 1837-1840, 1857-59, 1873-75, 1892-94, 1907-08, and 1929-32 (p. 538). Detailed histories of these cycles are related in Hoyt (1933), Sakolski (1932), Hicks (1961), English and Cardiff (1979), and other works, including many studies of the Great Depression. A few highlights of this history will be related here to document the consistency of the historical record with George’s theory.

    The revised Georgian business-cycle theory in this paper has the following premises: 1) real estate is a significant component of national wealth and national product; 2) real estate has been subject to wide fluctuations in price; 3) these fluctuations, facilitated by the money and credit markets, are in large measure induced by government expenditures and policies; 4) real estate speculative booms can raise the costs of business, and construction booms are a major portion of investment; 5) historically, real estate values and construction have peaked shortly before major depressions.

    The elements of the Georgist theory are: 1) Land is essential for all production. 2) In any particular economic region, the supply of land is inelastic; it has a fixed supply. 3) When a boom is underway, the anticipated increase in land values induces speculators to buy it for price appreciation rather than for present use, which causes its current value to rise above that warranted by present use. 4). Once wide-spread speculation sets in, land values are carried beyond the point at which enterprises can make a profit after paying for rent or mortgages. Production slows down, reducing aggregate demand. The slowdown ripples through the economy, increasing unemployment and bringing forth a depression.

    Historically, land values have had large fluctuations. In Chicago, total land value in current dollars was $160,000 in 1833, $10 million in 1836, $1.2 million in 1842, $125 million in 1856, $60 million in 1861, $575 million in 1873, $250 million in 1877, $1.5 billion in 1893, $5 billion in 1926, and $2.5 billion in 1932 (Hoyt, 1933, p. 254). As Hoyt observes (p. 233), fluctuations in so important a variable cannot fail to affect the entire economy.

  9. Josh commented on Sep 1

    I’ve been trying to time AMEX:SKF in my short portfolio for almost exactly a year now. Through a combination of my own imperfect human discretionary timing and fighting the Fed, who seems to rear his ugly head every now and then unannounced, I’ve been able to get the same results as if I had just put the money in from last Aug. 07′ to this Aug.08′ .

    In essence, I’m looking for an optimal short fund to rotate in/out on a quarterly, bi-yearly, and yearly basis or based on some other metric as described below.

    The following well research study by the Anderson business school in UCLA correlates the business cycle and how housing has influenced this cycle since the Depression.
    If we fast forward to the conclusion, Pg.51, this is the meat of the doc.

    “The temporal ordering of the spending weakness is: residential investment,
    consumer durables, consumer nondurables and consumer services before the
    recession, and then, once the recession officially commences, business spending
    on the short-lived assets, equipment and software, and, last, business spending on
    the long-lived assets, offices and factories. The ordering in the recovery is
    exactly the same.”

    1) Could you match the current “temporal ordering” we are currently blessed with with?
    2) Are these “Temporal Orderings” in the right order?
    3) From the answer to #1 above, could you assist me with matching the best short fund one could use to optimize their gains by pairing our current a “temporal ordering” with this fund?

    My call is that we are in the Consumer Services “Temporal Order” phase and the AMEX:SCC Profunds is the most appropriate short fund to map right now at this time.
    Any advice would be appreciated.

    Thank you in advance,

    FYI – Here is an update from the recent Jackson Hole trip from the above research.


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