Thursday, February 13, 2014

Demand for Housing and the Economic Effects of the Housing Recovery

Tyson Smith, Economist

At the end of 2013, DWS Economists Lecia Langston and Jim Robson explored housing prices during the recession and recovery (here and here).  Their research shows that Utah home values  declined faster than the national average during the housing crisis,  then recovered faster than the rest of the nation after the market bottomed out in mid- to late-2011. Furthermore, median home values in the state have consistently been above the national median over that time.

Click on Graph to Enlarge Image
Home price trends tell an interesting and valuable story about the recovery. Growth in home values increases the net wealth of home-owners and injects confidence into the consumer market.  Expansion of consumer wealth and confidence encourages consumption, which generates economic growth.

However, the question remains, what drives changes in housing prices? Classical economic theory defines the price of any product or service as a function of supply and demand1. Figure 1 highlights the turnaround in the demand for housing. Housing sales in Utah and the United States plummeted 38 and 46 percent, respectively from their peaks in 2005. Home sales started to pick up momentum in 2011 and 2012, which corresponds directly with increases in housing prices. The surge in housing demand put upward pressure on prices while simultaneously diminishing inventory, which further inflated housing prices.

The housing market recovery contributes to a positive feedback loop that encourages economic growth. Simply put, increases in housing demand compounds the value of homes, raising the wealth and confidence of home-owners, which leads to surges in consumption. The resulting economic expansion from increased consumption reinforces the demand for housing, and the cycle starts over. The feedback loop perpetuates growth as the business cycle moves from contraction to recovery2.

1The reality of pricing in the modern global economy is much more nuanced and complex than the simple models used to describe a perfectly competitive market. However, the economic assumptions applied to the theories of supply and demand provide a construct for understanding the exchange of goods and services in a free market economy.
2For more information about the determinants of supply and demand, or the positive feedback cycle created by the housing recovery see this and this.

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