Gross domestic product and its components in recessions

The recent economic crisis – already deservedly labeled the ‘great recession’ – continues to plague the health of the economy as a whole and has motivated us to probe its characteristic features and compare it to the typical economic downturn. Events during the boom and crash have been sharply delineated, progressing from (1) an unprecedented housing price bubble from 1997 to 2006, (2) rapid house price decline beginning early in 2007, (3) freezing of credit markets in August 2007, (4) rapid declines in equities prices and economic output by the middle of 2008, and (5) deterioration of the financial system in 2008 and an aggressive and unprecedented Federal Reserve intervention in the fall of 2008. This sequence of events has provided a fresh perspective with which to examine past economic cycles, and, we believe, is likely to change how economists, policy makers, investors, and others think about monetary policy, housing cycles, and business cycles. We find that eleven of the most recent fourteen economic downturns in the U.S. – from the great depression that began in 1929 to the great recession starting in late 2007 – were led by declines in housing investment. In these eleven downturns, housing investment declined before any other major component of GDP and its total decline before and during the recession was larger in percentage terms than the decline in any other major sector. In the 1945 recession – one of the three recessions in which housing was not implicated – national defense expenditures fell while all major components of private expenditure rose. The other two – in 1937-38 and 2001 – resulted primarily from declines in non-residential fixed investment that preceded and exceeded declines in any other major component of GDP. Figure 1 shows the percentage of GDP contributed by housing expenditures over the past 81 years. Although housing is not a large component of GDP – which may explain its limited role in accounts of recessions – it is volatile, it has declined before almost every recession, it has rarely declined substantially without a recession following soon afterward, and the extent of its decline emerges as a good predictor of the depth and duration of the recession that follows.2 In addition to its role as a leading indicator, and its volatility over the business cycle, housing investment has recovered faster than any other sector of the economy in every recession since 1921, with the single exception of the 1980 recession, which lasted only 12 months.