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America is “almost surely in for a long slog”

Recent research by Vernon Smith et al. shows "all the postwar recessions and the Great Depression leads to the following empirical proposition: If there is no recovery in housing expenditures, confirmed by a recovery in consumer durable goods expenditures, then there is no economic recovery."

In the Great Depression and in every recession since, recovery of residential construction has preceded recovery in every other sector, and its recovery has been far larger in percentage terms than the recovery in any other major sector.

Applied to the Great Recession, it appears that those who see signs of a recovery may be grasping at straws. What one should hope is that this time it is different from every one of the past 14 U.S. downturns, but those who believe this have the weight of past experience against them.

We looked at all the major expenditure components of Gross Domestic Product in percentage deviations from their levels in the fourth quarter of 2007, officially declared as the start of the Great Recession by the National Bureau of Economic Research.

The onset of and decline during this recession were like previous recessions, though its course has been deeper and longer. By quarter four of 2007, sales of new homes had fallen without interruption for nine straight quarters and expenditures on new residential construction had fallen for seven quarters—strong lead time signals of the looming distress. New home sales recovered briefly in 2009 but have now declined for three quarters. Residential construction expenditures have essentially been flat for five quarters. Consumer durables spending at best has stabilized, up slightly from its low in the fourth quarter of 2008.

The average increase in new residential construction in the first year following the previous 10 postwar recessions has been 26.3%. The largest increase in residential construction followed the 1981-82 recession, when it increased 75.5% as monetary policy was relaxed. In the past year, residential construction has increased 6.3%. This is the slowest rebound in residential construction in any sustained recovery from a postwar recession.

No currently debated policy will likely change this situation, as the market is saturated with foreclosed houses and homeowners suffer from $771 billion in negative equity. This fact needs to be confronted: We are almost surely in for a long slog.

Mr. Gjerstad is a presidential fellow at Chapman University. Mr. Smith is a professor of economics at Chapman University and the 2002 Nobel Laureate in Economics.

Link to the full text of the research paper


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