It’s the housing market, stupid

Thanks to @PeterBoettke on Twitter, I found these articles by Vernon Smith (an economics Nobel winner) and Steven Gjerstad arguing that the housing market has had a central role in the 2000s bubble and subsequent crash, because of its importance to household and lenders’ balance sheets. The first article (of 3) suggests that the Taxpayer Relief Act of 1997, which exempted homes from the capital gains tax up to $500,000, might have helped to trigger the bubble in house prices that ran from then up to 2006. The authors suggest:

Proposition 1. Severe economic recessions have their origin in joint household and bank balance sheet crises.

Proposition 2. The Great Recession is an example of a housing boom-and-bust that devastated the economy – as is (Proposition 3) the 1930s Depression.

Proposition 4. Monetary policy is ineffective in a balance-sheet crisis and so is government deficit spending for the same reason (which is that both operate on income flows at a time when households are repairing balance sheets).

Part 3 is still to come, but the articles are based on a recent book (which I’ve not read), Rethinking Housing Bubbles: The Role of Household and Bank Balance Sheets in Modelling Economic Cycles.

Rethinking Housing Bubbles: The Role of Household and Bank Balance Sheets in Modeling Economic Cycles

This struck a chord for two reasons. One is that Kate Barker’s new book in the Perspectives series, Housing: Where’s The Plan, also emphasises the way the housing market drives the economic cycle, and has as one of its central recommendations capital gains tax on primary dwellings. She, of course, was a long-serving member of the Bank of England’s Monetary Policy Committee and also authored two landmark reports on planning and the housing market for the Treasury.

The other reason has been my growing conviction (over the last two books, The Economics of Enough and GDP) that economists and policymakers have paid far, far too little attention to assets in general. But perhaps people in general have become a bit less short-sighted? It would help explain the growing disillusion with politics by the next day’s or hour’s headlines.

Housing: Where’s the Plan? (Perspectives)

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