Where's the Spillover from Housing?
Recently, the argument has been made that outside of the housing market, the economy is actually doing pretty well. Looking at the GDP numbers, that argument appears to hold some weight. Once you take into account the direct impact of large declines in residential investment (it fell an annualized 25.5 percent in the first quarter of 2008), GDP growth looks pretty good over the past two quarters: According to the preliminary estimate, GDP excluding residential investment increased 2.0 percent in the first quarter of 2008, following a 1.7 percent gain in the fourth quarter of 2007. While these numbers may be encouraging, they seem at least a little peculiar, given what we know about housing and what we've seen in the labor market.
Aside from providing a place to live, homes provide many services for their owners. They are a means of forced savings, a storer of wealth, and, in most cases, a household's largest asset. With homes so important to a household's financial situation, how is it that a serious downturn in housing can have such a limited effect on the rest of the economy? One factor that helps to explain the persistence of GDP growth is the global economy. GDP measures the value of goods produced in the United States, but not all of these goods are consumed within its borders. While demand for U.S. goods may have slowed within the United States, rapid growth in the global economy has added to it. The increase in foreign demand has been further boosted by a weak dollar, which makes goods and services priced in dollars cheap relative to goods and services priced in other currencies. The increase in demand from outside of the U.S. helps to keep production in the U.S. from falling off, ultimately boosting our GDP. We can see this in the relative strength of export growth.
Meanwhile, to see the strength of domestic demand by itself, we can look at gross domestic purchases. This series, which is essentially GDP less net exports, has grown much more slowly than GDP in the past two quarters, perhaps reflecting a negative wealth effect from the downturn in housing.
After adjusting for the direct impact of the downturn in residential investment, we still see some slowing in overall domestic purchase growth over the previous two quarters but not to the extent that purchases have actually fallen. This slowdown is likely partially the result of spillover from the housing downturn, but it should also reflect the impact of factors unrelated to housing that are weighing on consumers, such as rising food and energy costs. Still, the overall persistence of the series suggests that the spillover effect from housing has been relatively small.
One reason we still see no large-scale spillover may be that households view the downturn as transitory and just aren't adjusting their spending significantly This behavior requires, of course, that households have either enough wealth or available credit to buffer the temporary downturn. For some, this is certainly an issue, but in general, households still have a significant amount of equity in their homes to borrow against, and despite the credit crunch, households' nonmortgage borrowing appears to be robust.