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One of our centerpieces in analyzing this cycle dominated by housing is a
Federal Reserve Study finished in September of 2005 entitled
House Prices
and Monetary Policy: A Cross-Country Study. The 65-page treatise covers 35
years and housing cycles in 18 different countries including the U.S. While
too extensive to go into detail here (and too singular to rely on entirely)
I will summarize the critical two paragraphs:
- We find that real house prices are pro-cyclical and tend to reach a
maximum near business cycle peaks, often after a prolonged period of
buoyant growth in activity has raised output above its potential level and
inflation pressures have begun to emerge. Subsequently, real house prices
fall for about five years and their previous run-up is largely reversed.
Real GDP growth slows during the first year or so after house prices peak
as do growth rates of private consumption and investment.
- House price booms are typically preceded by a period of easing
monetary policy with FF rates bottoming out about three years before house
prices peak. Rates then reverse quickly (after the peak) in response to
falling GDP growth (my emphasis).
While there have been myriads of Fed studies, many of which have proved
fallible, I find many of the statistical correlations and conclusions in
this one highly significant and certainly eerie in terms of the current U.S.
housing boom: FF bottoming out three years (July 2003) before a housing
price peak (July 2006?); buoyant GDP growth and inflationary pressures
beginning to emerge (1st half 2006); and of course the critical follow-on
conclusion shown in Chart III, a quick reversal of rates shortly thereafter
(1st half 2007?).
On average, short rates have fallen by over 400 basis points once a
peak in housing prices has been established, a necessary function of
central bank policies worldwide in order to rejuvenate asset prices –
housing, equity, and bond markets among them.
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