Friday, March 10, 2006

The broader economy and housing

Housing prices in the US have appreciated dramatically over the past few years, adding billions of dollars to American paper wealth. The question is, once those prices flatten (or fall) what will happen to consumer spending, and the broader economy?

St. Louis Federal Reserve Bank President William Poole thinks the impact will be slight
"I base this forecast on the belief that the FOMC (policy-setting Federal Open Market Committee) will keep underlying inflation low and stable, and that the growth of real household income will recover nicely due to the waning influence of last year's spike in energy prices.

Calculated Risk argues against this saying that
I think the substantial mortgage equity withdrawal (MEW) in recent years contributed significantly to GDP growth, and declining MEW will be a significant drag for the next few years.

I don't know who is right. It is true that homeowners are taking equity out of their houses (growth in debt in Q42005 was matched only by growth in 1985), but I get the sense that most of that money is going right back into houses. I have not seen people splurging on luxuries or consumer goods like they did in the 90s Internet boom, but I have seen people load up with debt to get into a house. When the Internet bubble collapsed, the fallout was most acutely felt by people who worked at Internet companies, or for companies that served Internet companies. If housing prices fall, it will hurt homeowners who are long housing, but it will help the marginal homebuyer as prices are now much lower. I do expect mortgage issuers, real estate agents, and builders to take a big hit, but many people in those industries should clearly be working somewhere else. (By this I don't mean they are incompetent, I just mean that they are unnecessary in the same way was unnecessary).


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