The current economic recovery officially began in November 2001, and the recovery process has involved respectable growth in economic output (real GDP). But the recovery has had some deeply troubling aspects as well, with widely different implications for various sectors of the economy. Happily, the balance of pluses and minuses has been quite good for housing.
The growth of economic output since late 2001 has been driven by an incredible surge in growth of labor productivity (output per hour). In the process, the number of payroll jobs and the number of hours worked in the economy actually has declined. The resultant slack in the labor market has also enabled businesses to hold down labor compensation rates for those with jobs. Indeed, growth of average hourly earnings slowed during the 2001 2003 period, slipping to their slowest pace in more than a decade.
Dramatic cuts in labor costs have, in turn, put downward pressure on the prices of goods and services produced in the U.S. economy. This "disinflationary" process pushed key measures of core inflation (excluding food and energy) below 1 percent in late 2003, the lowest reading in four decades.
The productivity-driven problems in the labor market pose obvious problems for the housing sector as well, since growth in employment and household income naturally are positives for housing demand. Fortunately, the productivity surge has actually bolstered housing affordability by driving the interest-rate structure to historic lows.
The Federal Reserve has reduced short-term interest rates to the lowest level in 45 years and plans on holding them down for an extended period. The Fed will do everything in its power to prevent a Japanese-style deflation from developing in this country, and our central bank has stressed that the dimensions of the disinflationary productivity surge are very difficult to forecast. The Fed also knows that there's plenty of room for strong growth in economic output before tight labor markets pose any threat on the inflation front.
Evolving economic conditions and the Fed's consistent messages virtually guarantee stable monetary policy for most, if not all, of this year. Also, the Fed's monetary policy stance, along with the deceleration of core inflation, has maintained downward pressure on long-term rates despite the ongoing upswing in economic output. The long-term mortgage rate was about 5.9 percent in late 2003, and the NAHB's forecast shows only a half-point rise over the course of 2004.
Last year turned out to be a record year for housing in many ways, and 2004 is likely to be nearly as good despite some modest upward pressure on interest rates as the year develops. The NAHB is forecasting only slight declines from the 2003 records for home sales and single-family housing starts, with a bit more erosion in the multifamily market (primarily market-rate rental housing). Prices of single-family homes should post gains of about 5 percent, and remodeling of owner-occupied housing promises to post further real (inflation-adjusted) growth. Solid demographic foundations, combined with the broadly favorable economic and financial market factors (including delayed but decent job growth), should not only generate these housing patterns in 2004 but also pave the way for a good 2005.