Understanding the Lesser Depression 2.2.2: The Great Moderation: The Great Moderation: Accounting for the Great Moderation
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Understanding the Lesser Depression 2.3.1: The Great Moderation: The Global Savings Glut and the Housing Boom: The Housing Boom

Understanding the Lesser Depression

*J. Bradford DeLong, U.C. Berkeley, September 2011

(2) The Great Moderation

2.3 The Global Savings Glut and the Housing Boom

The Housing Boom

But the collapse of the Great Moderation was still in the future as the U.S. and the world economy recovered from the relatively small recession and downturn in the early 2000s that had followed the collapse of the late-1990s dot-com boom. The recovery of the 2000s did have a somewhat odd shape that puzzled and worried many economists, who wrote papers about and tried to puzzle out the logic of two phenomena, the global savings glut and the housing boom.


Figure 6 shows the relative intensity of two different flows of investment spending in the U.S. economy since 1995. The blue line tracks business investment in machines—producer durable equipment (and software) divided by the Congressional Budget Office’s estimate of the economy’s productive potential. The dot-com boom in information technology and telecommunications is clearly visible in Figure 6: investment in PDE rises from 5.5% of potential GDP in 1995 to a peak of more than 8% of potential GDP in 2000. It then fell back, not because the technologies of the internet, of modern computers, and of modern telecommunications were disappointing but rather because it proved unexpectedly difficult to make profitable businesses out of them. Nevertheless, investment in PDE as a share of potential GDP recovered to its 2000 level by the mid-2000s—and is closing on on its year-2000 level today.


As equipment investment fell, however, the question arose: what would be the next leading sector to soak up American labor and capital that had been rendered unemployed in the recession that started in 2001? It was not plausible that there would be a second information technology boom so close on the heels of the first, and biotechnology was too new and unbaked for it to develop the kind of mass demand that would power a boom on the scale needed to matter for the American economy as a whole.

The answer was housing. Investment in residential construction rose from 5% of potential GDP in the second half of the 1990s to a peak of more than 6% of potential GDP by 2006, and the number of houses on which construction was started in America rose from its usual pace of perhaps 1.5 million a year to a peak of more than 2.2 million by 2006.


Why did housing construction boom? Because people in the mid-2000s were willing to pay a lot more for houses. Figure 8 plots real housing pries—the FHFA’s housing price index divided by the Consumer Price Index. Before 2000 the real price of housing showed little variation on a country-wide scale. Prices in 1979 were perhaps 15% above what they had been in 1975 and would be in 1984. Prices in 1990 were perhaps 6% above what they would be in 1995. And by the peak of the dot-com boom in 2000 prices were perhaps 9% above what they had been in 1995.

But housing prices country-wide exploded in the 2000s. Why?