The 2 Indicators That Make or Break Every Recovery: Houses and Cars

The collapse of the housing and car markets plunged us into the Great Recession. Could reviving them be enough to get us out?

Economist James Hamilton asked the question in a recent Econobrowser post, and his answer, as you might expect from a thoughtful academic, boiled down to a big maybe. But some of the data he digs out while exploring the issue tell a truly remarkable story about just how vastly the health of these sectors influences the U.S. economy. On average, houses and cars account for just 8 percent of America's GDP. But when it comes to economic growth (or contraction), both markets punch way above their weight. That's because they're both prone to dramatic seesaws: they perform exceptionally well when the economy is healthy, and exceptionally poorly when it's ailing.

Cars and houses accounted for half of the economic decline that occurred from late 2007 to mid-2009. But as you can see in the graph below (adapted from tables in Hamilton's post), that's a somewhat smaller fraction than in some past recessions.

In 1973 and 1980 the United States was grappling with oil crises brought on by conflicts in the Middle East as well as a Federal Reserve bent on fighting inflation with sky high interest rates. When the price of fuel rapidly rises, it cuts into sales of gas-guzzling cars -- an old standby of U.S. manufacturing. When interest rates skyrocket, nobody can afford a mortgage. Mix it all together, and you decimate consumer spending.

The Great Recession unfolded a bit differently. Instead of a Fed-induced housing slowdown, we experienced a series of misfortunes including a bubble-induced run-up in housing prices, a mass foreclosure crises, out of control oil prices and, finally, a full-blown financial meltdown. But the symptoms -- a frozen real estate market and plummeting car sales -- were much the same.

But when our economy has bounced back, housing and cars have been responsible for a huge amount of immediate post-recession growth, although the proportion has decreased in recent years.

And as this final graph illustrates, the best recoveries are those where houses and cars bounce back strongest. During the muscular Reagan recovery, the economy got a 2.37 percentage point boost from those two sectors alone. Note that, at the moment, cars and housing are barely giving us any uplift at all. By Hamilton's estimate, if spending on homes and vehicles was to return to normal, it could add a full 2 percent to GDP.

All of this leads to questions about cause and effect. Is the case that when the economy heals, people start buying homes and cars again? Or is it that what's good for General Motors is still truly good for the United States? It's probably a measure of both. Families won't start buying new sedans or suburban three-bedrooms until they feel financially healthy. But once they do start buying, it can mark the beginning of a virtuous cycle, where spending on big ticket items helps move the whole economy forward.