Housing market faces intractable problems with demand
A federal reserve study concludes weak demand in the housing sector is structural and will not be corrected by low mortgage interest rates.
The federal government set up the unemployment reporting procedures to mask the depth of problems with deep recessions. During the Great Depression unemployment hit very high levels because the government counted everyone who wanted a job but didn’t have one. During the Great Recession, many people fell off the reported unemployment statistics because after a certain time, the long-term unemployed are deemed to be no longer looking for work even if they are.
The sharp decline in the labor participation rate in the Great Recession reflected the large number of people who were unemployed so long they were dropped from the labor force entirely. This made the reported unemployment rate look better than it was, which is why the government manipulates the statistics this way.
The change in the labor participation rate has big implications for the economy, monetary policy, and the housing market.
If we assume the decline in labor participation rate is temporary and discouraged workers will return to the workforce, then stimulatory monetary policies like quantitative easing and zero percent interest rates will eventually put these people back to work (at least the federal reserve hopes so). If these workers go back to work, they will ultimately buy homes, and sales volumes and sales prices will increase.
However, if the decline in labor participation rate is the early retirement of baby boomers, then these workers will not return to the workforce, and stimulatory monetary policies will be ineffective. Further, without increased labor participation, the workers who would buy homes from the baby boomers at inflated prices won’t materialize, and the housing market faces an intractable problem with long-term demand.
Considering the federal reserve has lowered interest rates to zero and printed trillions of dollars, it would be logical to assume they believe the labor participation rate will improve and they should continue stimulatory monetary policy; however, their economists are suggesting otherwise.
By Pedro Nicolaci da Costa, September 4, 2014
A decline in the share of Americans holding or seeking jobs is largely the product of longer-term factors such as a rising number of retirees rather than the aftermath of a particularly awful recession, economists at the Federal Reserve board say in a new paper.
The U.S. labor force participation rate was 62.9% in July, down from 66% in December 2007 when the recession began and a peak above 67% in 1999.
Fed officials have long debated how much of the recent decline in labor force participation is “structural,” and therefore more intractable, or “cyclical,” the result of an unusually weak economic recovery.
The difference matters for the central bank because the latter type is more likely to be reversed by Fed policies aimed at boosting economic demand, such as holding interest rates very low. The hope has been that if the economy strengthens, some people who have stopped looking for work—and therefore aren’t counted as part of the labor force—would return to the job market. But if the drop is mostly structural, then very low interest rates aren’t likely to make much difference.
The new research comes down squarely on the structural side of the argument.
The most recent debates around federal reserve policy has been around when they would start raising interest rates. Most assume they will leave interest rates down for too long and accept a moderate amount of inflation; however, if they believe the problem is structural, they may not follow that course. They may raise interest rates sooner to keep inflation low.
“Much of the steep decline in the labor force participation rate since 2007 owes to ongoing structural influences that are pushing down the participation rate rather than a pronounced cyclical weakness related to potential jobseekers’ discouragement about the weak state of the labor market,” several top central bank staffers write in a paper set to be presented at a Brookings Institution conference next week.
If they are right, this has major implications for housing. The low demand we see today may be a long-term structural problem with the housing market. Improving employment and wages may not have a major impact on housing because the raw numbers needed to really move the housing market is absent. It also suggests that homebuilding stocks may not be a great investment as demand for new homes will be low for the foreseeable future as new workers buy the existing houses of baby boomers.
The findings are part of an ongoing evolution in thinking for a central bank that until recently gave much credence to the notion that weak demand was the primary factor holding down job market participation. In a speech last month, Fed Chairwoman Janet Yellen appeared to subtly shift her message, arguing that “along with cyclical influences, significant structural factors have affected the labor market.”
That was different from her first public remarks as Fed chairwoman in March. “A lack of jobs is the heart of the problem when unemployment is caused by slack, which we also call ‘cyclical unemployment,’” she said then. “I believe there is still considerable slack in the labor market.”
When Yellen made that speech, she obviously believed the problem is not structural. Will this new paper change her mind? If so, how will that impact monetary policy?
When Ms. Yellen spoke in March, the nation’s jobless rate was 6.7%. It has since fallen to 6.2% in July. She has said recently that if improvement in the labor market continues to be more rapid than Fed officials forecast, they could raise interest rates sooner than widely expected. Many investors are expecting the first rate hike in the summer of 2015.
However, following some costly head-fakes in recent years, officials want to make very sure economic growth and job creation are sustainable before taking their foot off the gas—particularly with inflation still comfortably below the central bank’s target.
Personally, I don’t believe this report will have much impact. The federal reserve won’t raise rates until inflation forces them to, and that won’t happen for a while. If we have structural unemployment problems, we may not have any inflation for a long time. Interest rates may stay low longer than people expect, not because the federal reserve tolerates high inflation but because the inflation doesn’t materialize.