Monday, September 12, 2011

Consumer spending battered by housing market

The next big issue I was going to write about is the fiscal policy of the states.  Unfortunately, things are not going according to plan.  Those pesky things known as thoughts have entered my mind and have not allowed me to keep on my intended schedule.  Something that is important before proceeding is to think hard about the role of the housing market and debt in (a) the initial crisis and (b) the current depression of aggregate demand.

Many economists and commentators have held forth on the issues in the housing market prior to the crisis.  For the purposes of this blog, no blame will be assigned for the economic crisis.  Instead, the focus should be more upon what happened with housing prices and mortgage lending.  The following two graphs are included in a post in macroblog by John Robertson, Vice President and senior economist in the research department of the Atlanta Federal Reserve Bank.

As one can see from the S&P Case-Shiller National Home Price Index represented in the graph, housing prices grew virtually exponentially from the early 90s to sometime in 2006.  There is a lot of regularity in the shape of the graph.  It seems unreasonable that prices would rise so high when real wages were not even growing in real terms throughout the mid 00s and inflation throughout this period was very restrained.  Quite clearly housing prices were getting out of line.  Homes, in addition to being good places to stay, are considered a real asset.  When the housing prices rose considerably through this period, homeowners can feel richer and more able to add debt because they have an asset to back their liabilities.  Furthermore, banks more readily lend money when people have a real asset to back up their borrowing.
The above graph shows that throughout the early 90s to around 2000, mortgage debt made up approximately the same proportion of GDP, then rose substantially through 2006 or so.  What you see from the two graphs is that while housing prices have declined precipitously, the amount that people owe against their homes is still quite large.  This is all a drag on the economy because it affects their feeling of wealth and thereby their willingness to spend is diminished.  At the same time, a considerable portion of their debts are still with them and so less personal income is available for the types of expenditures that will raise aggregate output in the U.S. economy.

It is primarily for these reasons that Joseph Stiglitz, Paul Krugman and many other economists have emphasized the importance of the debt in the current depression.  It logically flows from this discussion that if there could be a significant write-down in household debt, it would make the prospect for a consumer-driven recovery more plausible. Some of these matters were covered in the earlier blog Consumer Spending after the Crisis, but the themes bear repeating and further elaboration before SocialMacro addresses fiscal policy in the states.

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