Shares of GDP
The housing boom reached its peak in mid-2005. Thereafter, for two and a half years, from mid-2005 to the end of 2007, the economy underwent a smooth long-run adjustment to changing expectations about the future. Housing went from being a sector to invest in to a sector to avoid. Residential construction fell by 2.5% points. But the money that would have funded housing went elsewhere--0.5% points of it into business equipment investment, and 2.0% points of it into exports--and full employment was maintained.
You can see this successful, "classical", full-employment structure shift if we examine changes in spending shares of GDP from their construction high-water mark in mid 2005:
Shares of GDP: Deviations from Mid-2005
It is only in 2008-9 that shifts away from construction spending are not diverted away into boosts in other components of autonomous spending. Thus it was the financial crisis, not the collapse of the housing boom, that gave us our First Lost Half-Decade, with only government purchases counteracting the downturn:
Shares of GDP: Deviations from Mid-2005: Focus on 2008-9
Since late-2009, residential investment has flatlined, and gross exports and equipment investment have recovered to their late-2007 levels, but have grown no further. Just as there was no offset in growing other components of autonomous spending to the 2008-9 further collapse in construction, so since late 2009 there has been no offset in growing other components of autonomous spending to the collapse in government purchases:
Shares of GDP: Deviations from Mid-2005: Focus on Post-2009
The 2008-9 downturn was something the financial crisis did to us--partially offset by the expansion in government purchases. The post-2009 stagnation in employment, production, and growth is something we have done to ourselves: cutting government purchases without a well-functioning credit channel to take up the slack was very bad mojo.
Are there any signs we will do better in the future? Will Jack Lew be a better Treasury Secretary than Tim Geithner and get housing moving again, or ease the flow of credit to business that might want to expand?
At least in teaching students, we now have a nice example of how the "long run" and "short run" are conceptual categories corresponding to different dynamic processes, not spans of time. That's a silver lining...
