Why Housing Can Still Pull the United States Out of Economic Doldrums

The recovering housing market will only help the American economy get back on its feet.

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After years of hindering economic growth, housing added to Gross Domestic Product in 2012, an important reversal given the sector's key role in pulling the nation's economy out of the doldrums in past recessions.

But while the real estate market has seen marked improvement, further growth in housing depends on access to credit for home buying and home building. Typically, the residential real estate industry leads into a recession with declines in activity as interest rates rise and households delay making big-ticket purchases. However, the sector then leads the economy out of a recession as interest rates fall, household formations increase, and home buying accelerates.

Housing did not play this traditional economic function immediately in the wake of the Great Recession, in part because historic price declines significantly reduced the wealth of American households. This has led to a slow but necessary process of household balance sheet repair, which has produced a recovery characterized by lackluster job growth and reduced household formation, both important drivers of housing demand.

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However, while the rest of the economy slowed in 2012, housing began to assume its leading role in providing outsized contributions of economic growth during a recovery. According to Bureau of Economic Analysis estimates, housing's share of GDP stood at a little more than 15 percent as of the third quarter 2012. Of that total, nearly 3 percentage points, is due to residential fixed investment (RFI)—the construction of new single-family and multifamily housing units, remodeling and improvements to existing homes, and brokers' commissions for the sale of housing. While the share of GDP due to housing services remains relatively constant year to year, changes in RFI can have large consequences for the overall health of the economy. In more typical periods such as the year 2000, the share of GDP due to RFI was 5.2 percent, almost twice what it is today.

In this Feb. 4, 2010 photo, a new home is under construction in Gilbert, Ariz.
A new home under construction in Gilbert, Ariz.

Driven by significant increases in housing construction, these economic gains are producing an increasingly broad-based recovery in housing, with one third of housing markets now considered to be improving. As RFI returns to its historical trend, GDP will continue to grow and more jobs will be created in the housing industry. In fact, RFI may generate more than 20 percent of total GDP growth in the final quarter of 2012, given higher construction starts and seven consecutive months of improvement in home builder confidence.

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But risks remain, including access to credit for buyers and builders, rising material costs, and policy proposals that would reduce housing demand. Some areas of the country are suffering from shortages of workers with necessary construction skills, which could also raise costs and inhibit further expansion in building.

Overall, the return of housing as a source of economic growth is something to be thankful for as 2012 comes to a close. It also represents an economic trend to watch as policy debates concerning the fiscal cliff and possible 2013 tax reform grow. With prudent policymaking, housing can continue to yield a virtuous cycle of job creation and additional housing demand.

Robert Dietz is an economist with the National Association of Home Builders (NAHB). Previously an economist with the Congressional Joint Committee on Taxation, Robert writes on housing and policy issues at NAHB's economics blog Eye on Housing. Follow Robert on Twitter at @dietz_econ. The information presented here does not necessarily represent the views of NAHB or its membership.