The Next Recession

When economists teach students about recessions, they always discuss the causes of these economic downturns. Their lectures cover a wide range of different events that ultimately led to recessions; these events include the following: sharp increases in oil prices, Federal Reserve policies that cause severe reductions in the money supply, a drop in asset prices, and so on. After hearing these lectures, students are often left with the impression that economists observe events as they unfold, knowing a recession is coming even though no one else shares their clairvoyant vision.

This perception gives economists way too much credit. It is relatively easy to analyze a previous recession and to identify its main cause. It is much harder to see the events of today and evaluate how important they will be in determining future economic growth. The main problem with predicting the future is that so many potentially important economic events are occurring at any given time; consequently, it is nearly impossible to know which events will turn out to be the most important. To make matters more difficult, there are always some events going on that could contribute to economic growth and other events that could contribute to an economic downturn. In real time, economists are very likely to think a particular current event will have a huge impact on the economic future; when in reality, some other event will drive economic outcomes. To make matters worse, an economist could believe a damaging event is important when it turns out that a positive event overwhelms all other events and causes robust economic growth. For instance, in current times, an economist may believe that Trump’s tariffs will lead to a recession, but it may turn out that his deregulation policies lead to eight years of uninterrupted strong economic growth. Conversely, economists may put too much weight on a positive event, ignoring a negative one that drives us into the next recession.

Despite knowing that I may be focusing on the wrong things, I worry about an activity that I observe today leading to a recession in the near future. More specifically, I have gradually been exposed to evidence of excessive speculation in the real estate market. First, during a bike ride, a friend mentioned that he was trying to flip a house. People usually become interested in flipping houses when they think housing prices will go up. He is placing a bet that housing prices will continue to increase. My friend has never tried to flip a house before, so all of a sudden, he became optimistic about future real estate prices. Next, a June 21 article in the Wall Street Journal reported that investors account for a record percentage of U.S. home purchases, accounting for 11% of purchases in 2018. These investors, like my biking buddy, are betting that they can make a handsome profit as housing prices increase.

The problem with this speculative purchasing is that a turning point will be reached when investors lose faith that housing prices will continue to rise. When this happens, they stop buying houses and they will desperately try to unload them. With fewer buyers and more sellers, housing prices will drop, perhaps by a large amount.

Falling housing prices are a cause of recessions that occur often enough to be mentioned in textbooks. To understand this link, consider the actions of a typical home owner. When she sees the value of her house decrease, she will decide to save more; mostly because her house was part of her retirement savings and now that the house is worth less, she will feel that she needs to save more for retirement. When she saves more, she also consumes less. Businesses will make fewer sales, causing their inventories to increase. With ample inventories on hand, firms will order less new products to stock their shelves, leading their suppliers to cut back on production. Economy-wide, the reduced production may be great enough to cause a recession.

Only time will tell if my current worries represent large enough future impacts on the economy to one day be discussed in economics classes as the primary cause of the next recession.