Housing Policy, Monetary Policy, and the Great Recession

Here's a link to a research paper the Mercatus Center has published by me and Scott Sumner.

Housing Policy, Monetary Policy, and the Great Recession

It's a combination of Scott's work on Federal Reserve policy and my work on the housing bust.  Here is our takeaway:

------------

Policymakers should not slow the economy in an attempt to prevent bubbles, which are not easy to identify in real time. Such efforts to reduce demand in 2007–08 were not only unnecessary but were also responsible for the reces­sion and financial crisis. 

Instead, US policymakers should adopt regulatory, credit, and monetary policies that can help stabilize the econ­omy, allowing the creation of an environment for healthy growth in living standards. Such an approach involves three components:

1. Reform zoning regulations in urban areas. This would allow for more construction of new housing, espe­cially in closed-access cities such as Boston, Los Angeles, New York City, and San Francisco, where con­strained growth is currently resulting in high housing prices. The United States could sustainably employ many more workers in home construction if restrictions on building were removed. 
2. Avoid a situation where lending regulations are most lax during booms and tightest during recessions. It was this sort of regulatory pattern that almost certainly exacerbated the severity of the Great Recession. 
3. Monetary policy should seek stable growth in nominal gross domestic product (NGDP). Rather than target­ing inflation and unemployment, policymakers should aim for a relatively stable rate of growth in NGDP, the dollar value of all goods and services produced within a nation’s borders. Attempts to use monetary policy to pop bubbles in individual asset markets such as real estate often end up destabilizing the overall economy. A stable NGDP growth rate, however, will provide an environment that is conducive to a stable labor market and a stable financial system.

------------

If you're interested, at the link there is a link with a pdf download.  We address a wide range of evidence, some of which I am certain you have not seen before.

Trends in Housing Supply

Here's a little sneak peak into some work I've been finishing up.   This graph shows the number of permits issued for single family homes and multi-unit projects (duplexes on up to high rise condos).  The measure is the number of units as a percentage of existing homes.  In other words, what is the gross percentage growth in the housing stock, due to single unit and multi unit building.  The black lines are the averages among all large metros.  The red lines are the averages among the "Closed Access" cities - New York City, Los Angeles, Boston, San Francisco, San Diego, and San Jose.

I find several interesting items to note here:

1) Of course, the Closed Access cities build single family homes at much lower rates than anywhere else.  Also, there was absolutely no supply response in the Closed Access cities in the single family market due to the subprime lending boom.  The rate of single family building was lower in 2005 than it had been in any year since 1996.  I have heard anecdotal defenses of the housing bust, claiming that even cities like LA had excess supply where single family homes were being built in the suburbs, where there wasn't really demand for them.  That idea is belied by the data.

2) However, as prices increased, there was a tremendous supply response in the Closed Access cities in multi-unit projects.  In spite of the horror stories of the local hoops one must jump through to build apartments, the Closed Access cities really are building many more apartments than they had before 2003.

3) Since 2004, in fact, the rate of multi-unit building in the Closed Access cities has matched the national average.  In the end, the regulatory obstacles create higher prices.  Potential residents push prices up until it is worth the trouble to build units.  The regulatory obstacles now are raising prices rather than pushing down new supply, relative to other cities.  This suggests that demand is inelastic.  Agglomeration effects, etc. are strong.  This is, in fact, bad news.  This suggests that the regulatory limits to multi-unit housing are more widespread than just the Closed Access cities.  As bad as the regulatory environment is in the Closed Access cities, other cities are not building multi-unit housing at a rate significantly higher than they are.

4) The deep cuts to mortgage lending since 2007 have cut into single family building in the Closed Access cities just as much as they have in other cities.  Building in the Closed Access cities has nearly recovered to pre-crisis levels, but that's all multi-unit.  In the 1970s and 1980s, it was common for multi-unit building to be double or triple what it is today.  To get anywhere close to that today would require a wholesale regulatory overhaul across the country.

Fortunately, the political center seems to be moving in that direction.  We have a long way to go.

I am finishing up a paper with much more detail on housing supply before the crisis, and another with much more detail on the influences on home prices.

July 2020 Yield Curve Update

The Fed is failing us.  It started out great.  The initial reaction to the pandemic was timely and forceful.  The yield curve on March 18 was signaling confidence.  But, since then, we have been slowly sinking into stagnation.  The long end of the Eurodollar curve is barely over 1% now.  It is true that forward inflation expectations have continued to slowly rise, though they are still well under 2%.

Here are two graphs of yields.  The first shows the Eurodollar curve at several points in time.  It is now at a new low.  The second shows the expected date of the bottom in short term yields.  The yield curve bottom is now settling in on March 2022.  The date is moving away from us over time, not toward us.  This was the pattern during QE1-3, when QEs were on, the date of the first rate increase would stabilize, but the Fed always cut the QEs off before we actually arrived at the date, and when they would stop the QEs, the date would move off into the future again.

When the yield curve inverted in 2019, the Fed reacted moderately well to it, and at least the expected date of the next rate hike was relatively stable, ranging around June 2021 for all of 2019.  Then, their aggressive moves in March actually briefly moved the date closer.  I thought that the pandemic might have actually kicked them into gear a bit to focus more on nominal economic recovery.  Briefly, in March, the expected first rate hike had moved as far as September - next month.  But that didn't last.

This is not a comment on all the emergency lending programs.  They simply should be buying a lot more Treasuries until nominal income or inflation expectations recover more.