Introduction
The business cycle and real estate cycle have a strong association. The statistical association between periods of booms and busts in house prices and periods of economic instability suggests that understanding the nexus between real estate markets and the real economy is likely to constitute a central issue and raises some important questions. Economists have defined business cycles as wavelike movements of increasing and decreasing economic prosperity. In such a phase employment dips considerably and there arises a rise in consumer goods prices. Presently the US economy is in a recessionary phase. This is due to the decrease in US consumer spending. Economists believe that real estate follows the trend of long-term business cycle. This has been supplemented by an increase in global oil prices.
Body
The US economy has been facing an economic downturn since 2004. The sluggish growth has been shown in figure 1 (see Appendix). Further the inflationary pressure on the economy is high which is currently at around 2% (Appendix, figure 2). This has adversely affected consumer confidence and US consumer spending has gone down considerably. This has in turn affected the GDP as it is primarily driven by consumer spending.
Sluggish growth rate has affected US consumer confidence which is reportedly at its lowest level in 16 years. Higher oil prices, high commodity prices and higher fuel prices are causing an inflation headache for the Federal Reserve. Analysts suggest that to tackle inflation Fed may increase the interest rates, but that will only worsen the economic slowdown. This situation has been described as “fire and ice” by the IMF.
The latest reading of US consumer sentiment also showed a worsening situation. Higher food and fuel prices and fears over the economy, jobs and wages mean that US consumers’ expectations for the next six months are at an all-time low, according to the Conference Board which polls 5000 households monthly. The percentage of consumers expecting business conditions to get worse over the next six months jumped to 33.9% in June from 32.9% the previous month. And the percentage of those expecting fewer jobs to be created in the months ahead rose to 35.5% from 32.3%.
Sluggish growth, high inflation, long-term high unemployment rate and rising oil prices have dipped the housing prices to an all-time low (Appendix, figure 3). In the housing market, property prices fell by their fastest rate since 2000, according to the Case-Schiller home price index. Prices in the 20 cities it monitors was 15.3% lower in April compared to the year before. The narrower 10-city index was 16.3% down, its biggest decline in its more than two-decade history. Las Vegas and Miami experienced falls of more than 25%, while the declines in Denver, Chicago and Cleveland were less severe.
Research has shown a decline of housing prices has been attributed due to the decline in consumer confidence which has been attributed to declining housing prices all over the US. “The economic pullback since last year has been led by slumping home construction and flattening business investment. But growth has remained marginally positive: The economy grew at a 0.9% annual pace in the first quarter of this year and will likely post a similar gain in the current April through June period. That’s large because consumers, whose spending makes up two-thirds of U.S. economic output, have remained resilient.” (Evans and Troianovski, June 2008).
Summary
Thus it is evident from the current US experience that with sluggish growth, consumer spending is affected, which in turn reduces consumer’s propensity to spend on real estate, thus creating a rapid decline in housing prices, as supply was exceeding demand in the real estate industry. So with a recession in the economy’s business cycle the real estate cycle to has taken a downturn. Thus we may deduce that the business cycle and real estate cycle have a positive association, as is evident from the American experience.
Reference
Kelly Evans and Anton Troianovski Battered Consumers Turn Glummer Home Prices See Sharp Decline; Pressure Grows for Fed to Hold Rates Steady. 2008 Wall Street Journal.
That ‘Sluggish’ Economy It’s still the strongest in the world. Review & Outlook. Wall Street Journal, 2004.