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Home Publications Blogs CEPR Blog Congressional Budget Office Projects the Return of the Housing Bubble

Congressional Budget Office Projects the Return of the Housing Bubble

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Written by Dean Baker and David Rosnick   
Monday, 19 March 2012 13:58

The Congressional Budget Office (CBO) does not exactly have a stellar record when it comes to economic forecasting. Back in 2001 failed to see the collapse of the stock bubble that led to the recession that year even though it was already well underway. It forecast both a decade of solid economic growth and continued strong capital gains and capital gains tax revenue.

CBO also never noticed the housing bubble. In January of 2008, one month after the recession is now dated as having begun and a year and a half after the housing bubble had begun to deflate, CBO projected nothing but blue skies. The annual Budget and Economic Outlook showed nothing by continued growth, low unemployment and near balanced budgets.

This track record suggests that CBO’s economic projections warrant serious scrutiny. In carrying through such due diligence, we happened to notice an unusual aspect to the projection in the most recent Budget and Economic Outlook.

These projections show that Federal Housing Finance Administration’s House Price Index will rise by 20 percent over the course of the decade after adjusting for inflation. This projection is striking because it suggests a sharp divergence from the pre-bubble pattern to house prices.

CBO-Jan2012_EconomicBaseline_Release_28963_image001

Source: Congressional Budget Office and authors' calculations.

Robert Shiller constructed a series on house prices in the United States from 1890. This series showed that from 1890 until the beginning of the housing bubble in the late 90s, house prices essentially tracked the overall inflation rate. CBO’s projection implies that it expects house prices will regain at least part of their bubble value.

This projection has some important implications for its economic projections. Higher house prices imply greater wealth. With the value of residential housing roughly equal to GDP at present, if house prices rise by 20 percent, it implies an increase in housing wealth equal to 20 percent of GDP. Assuming a wealth effect on consumption of 6 percent (i.e. homeowners spend another 6 cents annually for every additional dollar of housing wealth), this will translate into an increase in annual consumption of 1.2 percent of GDP.

If there is a multiplier on this consumption of 1.5, then the effect of CBO’s projected return of the bubble is to raise annual GDP by roughly 1.8 percent. Presumably higher house prices also imply greater levels of construction. If this 20 percent rise in real house prices increases construction by just 5 percent above trend levels, then the impact of this projected bubble is to raise projected GDP by more than 2.0 percentage points.

Of course CBO might be proven right and we may see house prices return to levels that are well above their long-term trend. However if they are wrong then it seems likely that the recovery will be even slower than CBO is now projecting, with the economy taking even longer to get back to its potential output and for the unemployment rate to fall back to more normal levels.

Tags: economy | GDP | housing | recession

Comments (2)Add Comment
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written by JSeydl, March 20, 2012 7:10
I don't know that we will see another home price bubble anytime soon. However, I wouldn't be surprised if we saw another asset bubble somewhere else, thereby making the CBO's economic projections accurate. After all, the main source of the American bubble economy remains in place. That is, the value of the U.S. dollar remains massively overvalued relative to the currencies in Asia. So long as the U.S. continues to run massive current account deficits, domestic growth will be characterized by asset booms and busts, which will continue to do tremendous amounts of damage to middle-class households.
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written by Ferox Hircus, March 24, 2012 4:57
Additionally, the projection for housing price inflation implies reduced unemployment via the Phillips Curve. This seems inconsistent with many unemployment projections. Unless there is a new, lower, full employment rate in the US. No one is talking about this right now but it seems to be a serious issue. The economy has been growing for two years at 8-9% unemployment. Consumption is at an all-time high in real terms. Firm's continue to earn increased profits with less capital expenditure. Small business is not able to make up the difference anymore. There has been a structural shift that may not reverse anytime soon. The US dollar relative to other currency is not what creates bubbles- capitalism does that inherently. The bigger issue is how to employ more of the domestic workforce in long term value-added production. I fear that the current model in common corporations today may lack the long term focus required to effectively employ the nations current resources, specifically labor.

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