Thread by @KAErdmann

Scott Sumner and I have a new paper on housing, monetary policy, and the Great Recession.
Tl,dr: The stuff you thought was settled fact is wrong. There is a lot to unlearn about the recession in order to learn what needs to be learned.

Thread....

mercatus.org/publications/m…

Myth: The Fed needed to stop a housing bubble. The reason the crisis was so deep was because the Fed waited too long and let the bubble get out of hand.
Reality: Rising home prices are an international phenomenon. Popping the “bubble” made us worse off.

Myth: Artificially low interest rates overheated the economy.
Reality 1: Interest rates are a terrible way to measure monetary policy. During the housing boom, the Fed was pushing up against natural downward rate trends.

Reality 2: There is little reason to believe the economy was significantly overheated before the recession. Neither inflation nor nominal income growth were unusual.

Reality 3: Money velocity was actually increasing during late 2007 and early 2008. More than 100 percent of the slowdown in NGDP growth was due to the Fed sharply slowing the growth in the monetary base.

Reality 4: The monetary base flatlined in 2007. Rates were falling in spite of the Fed. By September 2008, they maintained a 2% rate target in the midst of TARP, etc. even though they didn’t have enough securities to sell to hit the target.

Myth: The crisis was worsened because the Fed couldn’t cut interest rates below zero.
Reality: The drop in nominal GDP came when the Fed was futilely aiming to keep rates above zero. By the time rates hit zero, GDP had stabilized.

Myth: Artificially low interest rates overheated the housing market.
Reality 1: Single-family home sales were very high, but that was mostly taking market share from other types of housing.

Reality 2: Gross residential investment includes brokers’ commissions, which are inflated by the shortage of housing in places like LA. Other residential investment increased from the low levels of the 90s. Strong, but not unusually so.

Reality 3: According to BEA estimates, growth in real expenditures on housing has been lower than growth in other spending for 30 years. This was even the case during the so-called housing bubble.

Reality 4: Urban housing production has been so lacking that our most productive and most expensive cities bleed out domestic migration every year. This did not change during the housing boom.

Myth: Millions too many homes were built, fueled by irrational exuberance.
Reality 1: Rising local rents have become an increasingly important factor explaining home prices in different cities. This was true during the bubble and after.

Reality 2: Increased construction was significantly correlated with low vacancy rates. The boom was fueling building where homes were desperately needed.

Myth: Reckless lending to borrowers without adequate incomes caused prices of low-priced homes to skyrocket.
Reality 1: In most cities, during the bubble there was little difference in low-end and high-end price changes.

Reality 2: In all types of cities, prices in more affordable neighborhoods collapsed after the crisis because new lending regulations shut off longstanding sources of homeowner demand.

Reality 3: Mortgage originations continue to be much lower for all but the most pristine borrowers, and sales of new homes under $200,000 have dried up. At the same time, rents keep rising. Potential buyers can’t fund new homes.

Myth: Housing starts are low & prices collapsed even where prices hadn’t spiked very high because we overbuilt so much.
Reality 1: There were massive construction job losses in every state, regardless of previous building rates.

Reality 2: Even in 2009, vacancies were negatively correlated with increased boom era construction. IOW, even after the crisis there is no sign of systematic excess supply where building had been strong.

Reality 3: There was also no correlation between rising construction employment in a state during the boom and rising unemployment after 2007.

Reality 4: There was a strong correlation between high rates of building in 1998(!) and both high vacancies and high unemployment after 2007. That is because overly restrictive lending cut off longstanding migration trends.

Reality 5: The vacancies and economic collapse in the sand states weren’t the result of building too many homes. They were the result of a temporary migration surge out of cities with severe housing shortages that suddenly came to a halt.

So, 3 BIG LESSONS:
1-
Wrong Lesson: Too much money and credit led to too many overpriced homes.
Right Lesson: Prices were high during the bubble because we lack adequate housing in some important places. We needed more homes, not fewer.

2-
Wrong Lesson: A mortgage crackdown was necessary to bust a housing bubble.
Right Lesson: Lending policy should be countercyclical. Lending regulations have been pro-cyclical, employment killing, and wealth destroying.

3-
Wrong Lesson: The Fed should be in the business of keeping asset prices low because low interest rates are creating financial bubbles.
Right Lesson: This mindset caused the Great Recession. The Fed should target stable NGDP growth.

The End.

Scott will have a book soon that goes into more details on the monetary side of this.

I have a book out now that goes into more details on the housing side of this.

amazon.com/Shut-Out-Short…