South-Western College Publishing - Economics  
Can Housing Continue to Lift the Economy?
Subject Federal Budget Deficit
Topic Taxes, Spending, and Deficits
Key Words

Budget Deficit, Taxes, and Government Spending

News Story

The Commerce Department reported recently that new home construction was greater than expected in December of 2004. The housing industry completed their best year in a quarter of a century. In December alone, housing starts reached an annual rate of 2.09 million, the fastest rate since the 2.26 million annual rate in February of 1984. These striking numbers are causing some analysts to raise their forecasts for the industry in 2004.

This report bodes well for the economy which, in the face of slow job growth has relied on the building, buying, and refinancing of homes as a stabilizing force. All indications are that this same trend will continue. "Month after month, we've expected total housing starts to moderate a bit, but it doesn't seem to have happened," said Orawin T. Velz, a senior economist at Fannie Mae, the nations largest buyer of home mortgages. " With this rate in December, the decline in 2004 may not be much at all."

Much like business investment, new housing starts depend highly on interest rates and the Federal Reserve's willingness to keep interest rates low and more and more analysts are predicting that slow-growing job market will persuade the Federal Reserve to keep rates low. "I think increasingly it looks like 2004 could be better than 2003," said Michael Carliner, an economist with the National Association of Home Builders in Washington.

One component of investment spending in the national income accounts is spending on structures. Investment in structures includes expenditures on new homes as well as on structures intended for business use. When it comes to computing GDP, housing expenditures are the one form of household spending that are counted in investment spending rather than in consumption spending.

Since investment spending is the most volatile of all components of GDP, a stable and growing housing industry can prevent wide swings in economic activity and help keep the economy on the path of recovery. The one downside, according to some economist, is that a lot of the building activity would be speculative, resulting in an excess supply and a fall in housing prices and industry profit. "I look at this rate of building, and to me it's just crazy," said Dean Baker, co-director of the Center for Economic and Policy Research, a Washington research group. "Homes are being built in a way that is inconsistent with any plausible growth in demand." If Mr. Baker is right, the housing sector would be acting more like traditional business investment and introduce more volatility into the economy.


(Updated March, 2004)

Questions
1.

Define the term "investment," as used by economists.

2. Why is residential construction counted as investment rather than consumption?
3. As a home buyer, would you be more interested in the interest rate or the monthly payment in your buying decision? Why?
Source Jennifer Bayot, "Housing Keeps Driving Economy," New York Times Online, January 22, 2004.

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