Jim Hamilton shares his insights into a puzzling question: housing sector accounts for less than 5% of the total economy, yet why it, along with auto sector, tends to drive the US business cycle.

Two of the most important sectors in U.S. business cycle fluctuations are autos and housing. For example, in the 2007:Q4-2009:Q2 recession, real GDP fell on average at a 2.7% annual rate, with autos and housing accounting for about half of this decline all by themselves.

… Although autos and housing make a very significant contribution to changes in GDP growth rates over the business cycle, they represent only a small part of the level of total GDP. Over 1947-2011, spending on motor vehicles and parts only amounted to 3.5% of total GDP on average, while housing was less than 4.7%. But the fluctuations in spending on new cars and homes are so volatile, these percentages change quite a bit over the cycle, rising well above average during expansions and falling in contractions. For 2011:Q3, motor vehicles and parts represented 2.4% (or close to 30% drop) of the level of GDP, while residential fixed investment was only 2.2% (more than 50% drop).

The fact that the levels remain so low today relative to their historical averages means that housing construction and automobile manufacturing have fallen well below what’s needed to keep up with growing population. That suggests the potential for a significant positive contribution from these two sectors if the recovery could ever get back on track.

Read the full post here.