Build More Houses: How an Incorrect Perception of Housing Supply Fueled the Great Recession and Slowed Recovery

Abstract

An oversupply of housing, as a result of a building boom after the turn of the century, is commonly cited as a key cause of the Great Recession and the slow recovery from that recession. Using both national data and data for individual metropolitan areas, such as housing permits, residential investment, and population trends, I show that the evidence for systematic overbuilding is weak. New building was primarily meeting sustainable demand for shelter before the crisis. Building had increased where local regions with inadequate supply had created pent up demand and in regions where population was increasing as households were forced to move away from regions with inadequate housing supply. Elevated vacancy rates, where they developed, are best explained by unexpected declines in population growth. Declining population trends had already become problematic by 2007 in cities where high vacancies and collapsing prices were the worst after the recession. Yet, in 2007 and throughout the crisis, Federal Reserve officials acted explicitly on the perception that excess supply was an impediment to a recovery in residential investment, construction employment, and general economic stability. In short, an incorrect perception of housing oversupply rather than actual oversupply fueled the deep recession and slow recovery by prompting the Federal Reserve to accept or induce negative trends in economic activity.