This is how it’s supposed to work

Back in the early stages of the 2006-09 housing collapse, the economy behaved as it is supposed to behave. Housing construction fell by more than 50% from January 2006 to April 2008, but there was only a tiny rise in unemployment, from 4.7% to 5.0%. Jobs shifted from housing construction to other sectors. That’s how things work when the Fed is keeping NGDP growing at an adequate rate. You move along the production possibilities frontier, not inside the line. Indeed we would have done even better if not for the modest slowdown in NGDP during late 2007 and early 2008.

Then the Fed let NGDP growth collapse in the second half of 2008, and almost all sectors started shedding jobs. The unemployment rate soared to 10% as we moved inside the PPF.

The recent Covid-19 shock is even bigger, but there are a few heartening signs that we’ll avoid the worst. The Covid-19 epidemic has caused saving rates to soar much higher, as consumers hold back on buying many services. This depresses interest rates, with 30-year mortgage rates recently falling below 3% for the first time ever. This surge in saving also tends to boost sectors less impacted by Covid-19, such as housing construction:

US homebuilder confidence back at pre-pandemic levels

US homebuilder confidence jumped in July, taking it back to levels seen before the pandemic rattled the US economy as the 30-year mortgage slipped to a record low, data on Thursday showed.

The National Association of Home Builders’ Housing Market Index jumped to 72 in July from 58 the previous month. That exceeded economists’ forecasts for a reading of 60, according to a Reuters survey, and matched its reading in March.

It’s a myth that low interest rates are good for the economy. That’s “reasoning from a price change”. Low rates are often caused by a slump in investment demand, which is bad for the economy. But higher saving rates are good for the housing sector. If monetary policy is adequate, we should see a V-shaped recovery once the worst of the epidemic is behind us.

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