Is housing still the business cycle? Perhaps not

In 1998, I published a paper that showed that under a wide range of specifications, residential investment led GDP, while non-residential investment did not. That papers was followed by a number of others, including Coulson and Kim (2000), Davis and Heathcoate (2005) and Leamer (2007) that used more sophisticated techniques than my paper, but found the same outcome—that residential investment led GDP. Leamer famously announced that housing was the business cycle. But in light of the Great Financial Crisis, the subsequent crash in residential investment, and the fundamental changes in the mortgage market, I thought it worth revisiting housing as a leading indicator. I have found that it is a much weaker leading indicator than before, and that it is much less sensitive to Federal Reserve Policy—especially changes in the Federal Funds Rate—than before. It is possible that the increasing stringency of local land use policy had interfered with the ability of the Federal Reserve to use housing as an instrument on monetary policy.