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Housing starts have been stable for over a year

Housing starts have been extraordinarily weak since early last year, but the important news is that they have been relatively stable, and that is a good sign that the housing crisis is passing. While this chart suggests they are up at an 11% annualized rate from their all-time recorded lows, it's not much to cheer about. But since residential construction amounts to only 2.5% or so of GDP, whether starts rise or fall by 10% from here is just not going to make a great deal of difference to the economy.

I think the more important story here is that 1) housing was in excess supply in 2005, 2) at a time when prices reached very high levels in real terms, 3) causing a big decline in construction and a big decline in prices. That process of adjustment to an oversupply of housing and excessively high prices has now been underway for over 4 years. Construction has dropped by some 75%, to a level significantly below what is needed to keep up with ongoing household formations, and prices have fallen in real terms by about one-third on average. Both construction and prices have now been relatively stable for the past year. The commercial real estate market was a bit slow to participate in this big adjustment, but it too has seen huge price declines followed by an extended period of price stability (see chart below).

All of this suggests that the economy has had plenty of time to adjust to the housing crisis. There have been massive shifts of resources away from construction. This may be one of the biggest curve-balls the economy has had to deal with in my lifetime, but it is no different in principle from what happens during every recession: something happens that was mostly unexpected, and that results in the failure of many business and investment plans; people have to adjust their thinking and their plans to accommodate to a new reality; resources have to be shifted from the area that is suddenly out of favor to new areas that begin to emerge as favorites; and relative prices change significantly, as this is the market's way of encouraging people and resources to shift (e.g., some prices decline while others increase). Policymakers typically react too late to all this, and in their efforts to assist the process of adjustment, they invariably end up impeding progress.

But with the passage of time, the forces of recovery take hold and the economy begins to grow again. If policymakers correct their mistakes (e.g., by extending the Bush tax cuts and cutting back on spending), then the forces of recovery are going to get a big boost. Either way, the economy is growing and should continue to grow, and all those who worry about a double-dip recession will realize that they were fighting the last war.

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