A commenter asks

I have two questions. Why did residential investment appear to contribute so little to GDP prior to 2008. Is this predictive of the housing bubble’s burst or had the bubble really already burst? And why in the world did government’s contribution to the GDP fall off so sharply when the stimulus package was passed?

Its worth putting these graphs back up because I think the contributions help tell a story that’s hard to tell otherwise.

Here is Residential Investment

FRED Graph

You can see two things. First nothing about the early 2000s was super crazy. Second, the decline began in 2006.

This is very, very, very different from the story on home prices that most people focus on. Here we are talking about how investment of real resources there was in the housing sector.

That peaked around 2006. That means after 2006 the amount of resources devoted to the housing sector began to decline. The housing sector was recessing. Housing prices continued to rise and importantly houses continued to pour on to the market.

The purpose of the housing sector is to create and distribute housing. A shrinking housing sector does not mean that no housing are being created or that housing are being destroyed. It simply means that fewer houses are being created and distributed.

This as been going on since 2006. That is, the housing sector has been shrinking for approaching six years now. Indeed, it only stop shrinking because it just about hit zero. You can’t go lower than zero.

My best guess at the data is that now about as many homes are being created every year as are being demolished. This implies no net growth in the housing stock. This is a deeply shocking phenomenon.

My feeling is that understanding how this is possible will be key in the next generation of macroeconomics. What you are seeing is a strong relationship between asset price growth and the stock of the asset. However, both of these are utterly unmoored from micro-fundamentals and remain so to this day. Including the run-up in prices we are now looking at a full decade when either housing quantity or prices has been out of whack.

Now lets turn to government

FRED Graph

How can government be shrinking so much at exactly the time the stimulus passed?

Two ways: first a significant chunk of the stimulus was tax cuts. Second, much of the rest of the stimulus was aid to the states. However, the states were facing very severe revenue decreases and in most states the stimulus was not even enough to fill the hole.

So, even though billions were going from the Federal government to the states, the states were still shrinking. Importantly, most government services are actually provided at the state and local level.

So when state and local government shrinks, government shrinks. This can be confusing because so much of your taxes go to the Federal government. Yet, that tax money is primarily used either for the military or to fund services actually provided by someone else. The Federal government for example, pays for Medicare but it doesn’t actually provide medical care to seniors. The health care sector does that.

Similarly, the Federal Government provides student aid to college students but the Federal Government doesn’t actually operate any non-military universities. Those are either private or run by the states and in a few cases the local government.

Washington is vey powerful and glamorous but most of the business of running the US public sector is done by the state and locals.

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