Housing market continues to contract. Recent releases of home sales data show that weakness in the housing market is persisting. This week’s release from the Census Bureau showed that seasonally adjusted new home sales are down 4.7% from last month and down 40.7% from December 2006.  Additionally, the months’ supply of new homes is up to 9.6 months, compared with 6.2 months in December 2006. Previously, the Census Bureau released data on housing starts showing a marked deterioration in new construction (see chart).  Last month’s decline in the number of new housing starts is similar to what was experienced during the recessions in the 1980s.

Similarly, data from the National Association of Realtors (NAR) released last week showed seasonally adjusted sales 2.2% lower than in November and 22% lower than sales in December 2006.  Moreover, sales of existing homes in December declined in all regions of the U.S., including the West, while November’s decline was limited to the Northeast and the South.  Additionally, the median sale price for existing U.S. homes declined 1.4% between 2006 and 2007, the first decline since the NAR started tracking these data in 1968.

December employment reports were bleak.  The December employment report, released earlier this month by the Bureau of Labor Statistics, showed that the unemployment rate rose to 5.0% in December, an increase of 0.6% from last year, and a jump of 0.3% from last month.  Additionally, the number of jobs in the private sector declined by 0.13% at an annual rate.  Moreover, the employment-population ratio declined by 0.7% since November.  Last week’s initial jobless claims declined by 1,000, leaving the number of newly unemployed virtually unchanged.

To be sure, problems in credit markets are clearly visible in economic statistics.  Outstanding asset backed commercial paper, for example, has contracted by about one-third from its August value.    (See Snapshot)  But problems in the real economy are also apparent, and extend well beyond problems in housing, as can be seen in the data on nonfarm private employment.
Although rate cuts will help to stimulate demand, they are unlikely to be enough to forestall a significant downturn.  Monetary policy works through intermediaries, such as commercial banks and mortgage lenders, and it can take well over a year to be fully felt.  Moreover, when the economy is in decline, households and firms become more cautious and spend less, and this can counteract the effects of interest rate changes.
This explains why fiscal stimulus is also on the agenda.  A well-crafted program that increases spending can rapidly generate a predictable boost to the economy.  However, the “multiplier” or “bang for the buck” of potential stimulus options varies significantly.
It is generally recognized that transfers to income-constrained or credit-constrained households are likely to be spent rapidly.  So, for example, increased unemployment insurance payments or food stamp distributions are very likely to produce proportionally large, immediate impacts.  Tax rebates, especially when targeted to low- and middle-income households, are likely to have large effects.  On the other hand, tax cuts designed to stimulate business investment have smaller impacts, because investment decisions also depend on expected demand and other factors. (For a ranking of stimulus options see http://www.cbo.gov/ftpdocs/89xx/doc8916/01-15-Econ_Stimulus.pdf)
The overall effect of a fiscal stimulus depends on its total size, as well as the “bang for the buck” of its elements.  The stimulus packages currently under consideration are equal to about one percent of GDP.  If the adopted package has carefully chosen elements, which might result in an aggregate multiplier effect roughly equal to one, then it may add about one percent to GDP.  This would give the economy a decent boost.
If a truly big downturn is under way, however, a one percent stimulus may not be enough to prevent rising unemployment and declining growth.  In that unfortunate case, follow-on stimulus may need to be considered.