Monday, November 5, 2007

Lessons from Leamer: Part 2

Continuing from previous post.
  1. Housing shows up in the GDP accounting via employment generation. Price appreciation of houses is not part of GDP; and more importantly, increased land prices today if booked as an asset, a liability has to be entered. Where? Liabilities for future buyers. This is transfer of wealth from future generations to present generations!
  2. The stickiness of housing prices downwards means, most importantly, price cycles follow sales volume cycle. Also, the volatility of the housing volumes is much higher than the price.
  3. Sellers develop their expectations of prices from a backward perspective (“what did I pay for it compared to the offer price?”). Buyers have forward looking price expectations (“what will I get for the house 5 years from now”). So, sales only happen when there is a high bid price by sellers.
  4. In a housing boom, the fastest appreciation happens for small houses with low-income zip codes (and smaller square footage = condos and small homes). Predictably, during a bust – they get hit the most.
  5. To avoid business cycle fluctuations – one must avoid housing cycle fluctuations and job-losses in consumer durables.
  6. Monetary policy that acknowledges the two factors – must face up to the fact that if real interest rates fall temporarily, then for equilibrium level of housing stock will return to “normal”, only if production and sales fall and allow a return to the mean. In contrast, if real interest rates fall permanently, then equilibrium levels of housing stock will rise.
  7. Monetary policy that accounts for housing investment is a difficult inter-temporal resource allocation issue.
  8. Today, one observes the presence of weak housing starts (new houses being built) and increased inflation – resulting in a conflict for what the “right” policy prescription ought to be.
  9. In case of policy choices to be made between housing starts and inflation – there is no real conflict.
  10. The best predictor for Fed Funds rate is the 10-year Treasury bond yields.
  11. Its the Housing Cycle!

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