The U.S. economy, and all its fits, spurts, soaring highs, and sharply diving lows is the product of consumer-driven cycles, and not guided by business cycles as is commonly believed by economists, said Edward Leamer, director of the UCLA Anderson Forecast.
Taking the stage at the Federal Reserve Bank of Kansas City's annual Economic Symposium - held in Jackson Hole, Wyo., Leamer, also a professor with UCLA Anderson School of Management, presented statistics from the last 35 years and tracked 10 recessions since World War II. Of those 10 recessions, eight were, "preceded by substantial problems in housing and consumer durables," Leamer said.
The other two downturns - one fueled by spending cutbacks at the Department of Defense after the Korean Armistice in 1953, and then after the dot-com Internet bust in 2000 and 2001 - were caused by collapses in business investment in equipment and software, Leamer said.
"Except for those two special events, it's been a consumer cycle not a business cycle," Leamer said.
Leamer presented his paper "Housing and the Business Cycle," which was one of five papers offered during the Aug. 31 symposium.
Leamer was critical of the Fed for "neglecting the critical role that housing plays in U.S. recessions."
"In particular, the subprime mortgage crisis is a direct consequence of short-term interest rates held too low for too long by the Fed," Leamer said.
The Fed, in the wake of the dot-com bust, began lowering its target Fed Funds rate in January 2001 from 6.5 percent to 1.0 percent by June 2003.
Leamer offered the Fed a few suggestions on how to "make us happy." The first was a smooth business cycle - the goal for the Fed would be to make recessions less frequent, less severe, and shorter.
Next, the Fed should keep the workforce working productively and limit the speculative bubbles that absorb our time and that divert savings into low-yielding investments, he said.
Third, the Fed ought to limit the redistribution of wealth caused by market disruptions. Leamer gave an example of when unexpected inflation transfers wealth from lenders to borrowers. When housing prices appreciate, money goes from renters (future home buyers and owners) to current homeowners who get the benefit of that price appreciation.
Finally, Leamer asks that the Fed help keep balance sheets accurately reflecting reality. No more "phantom assets" making a company look in far better shape than it is.
"Housing is the most important sector in our economic recessions and any attempt to control the business cycle needs to focus especially on residential investment," Leamer said. "After a surge of building there has to be a time-out, like we are experiencing today, before building can get back to normal, and before this channel through which monetary policy affects the real economy is operative again. The Fed can stimulate now, or later, but not both."
To learn more about Leamer's paper, or to read one of the other four papers presented at the Fed's annual Economic Symposium, please check out: www.kansascityfed.org/home/subwebnav.cfm?level=3&theID=9954&SubWeb=5