One Cause of the Uneven Recovery: The Home-Buyer Credit

It might not be the entire explanation for why the economy has been sputtering recently, but it appears to be a part of the problem

Sometimes government stimulus efforts can do more harm than good. In a purely cyclical recession a confidence boost by the government can often help. If it improves the sentiment of businesses and consumers, then their spending won't decline as much and fewer jobs will be shed. But when a government action tries to act as a temporary remedy for a severe structural problem, it might just get in the way of the economy finding its new equilibrium and make matters worse. The home buyer credit appears to be the latter type of stimulus measure and may be part of the reason why the economy hasn't stabilized.

Knowing precisely the affect that the home buyer credit had on the economy isn't easy. It likely increased home sales and prevented some layoffs, but only for a time. After the credit disappeared in May 2010, home sales plummeted and any layoffs that were initially prevented would have occurred anyway. But for the year or so that the credit was in place, it stimulated the economy. Here's a chart that estimates the effect of the credit on just residential investment:

To create this chart, I took actually GDP growth (red) and then imagined what GDP would have looked like without the credit (blue). In my estimate, residential investment dropped to $321 billion in the third quarter of 2009 -- where it fell to when the home buyer credit was removed last summer and has hovered around ever since.

Here, you see that the third quarter of 2009's pop looks a little weaker. But growth looks better in most of the quarters that followed -- especially the third quarter of 2010, during which time the big fall in residential investment due to the credit's expiration cut GDP. Better home sales would have had some effect on other aspects of GDP as well -- but just like you're seeing here, removing those effects in later quarters would have created an adverse effect.

So what did the the credit accomplish? It instilled Americans with a sort of false hope that the recovery was stronger than it actually was. That led sentiment, and consequently spending, to rise for a time, only to fall again when people realized that the economy was worse than they thought.

If, instead, the housing market had been allowed to seek its bottom, it might be there by now -- or it would certainly be about a year closer. We could be seeing more activity in residential investment as a result. Imagine if the housing market was showing real signs of stabilization and if prices, which had declined since the bubble burst, were steady or modestly appreciating. You would instead have heard a narrative of a slightly tougher road to recovery, but one that actually persists. Instead, we have a uneven, tentative rebound that makes Americans even warier about the future.

To be sure, the housing market isn't the whole problem here, but it's certainly a part of the problem. Most post-recession recoveries include a rebound in the housing sector. In this case, that rebound was postponed due to the home buyer credit, which instead just provided a temporary bump. And in this recession, in particular, with over 2 million construction jobs lost, even modest lasting improvement in residential investment could make a big difference.

Image Credit: REUTERS/Jonathan Ernst