Analysis of Negative Equity Spells End of US Love of Homeownership Article by Dominic Rushe - Term Paper Example

1. Article Summary The article by Dominic Rushe d ‘Negative equity spells end of US love of home ownership’ appeared on the internet on Friday the 22nd of April, 2011. The article can be accessed at us-housing-market-still-in-doldrums. The article states about the situation of the housing market in the US; “it is still on the slide for five years and there is no sign of an imminent recovery.” Home possession degrees are now back to those levels as was seen in 1998. Some economists are even anxious that the USs may have lessened their love of property ownership. It looks that boom years had never occurred. Paul Dales, US economist at Capital Economics says that "You would have to go back to the Great Depression to find anything similar. It will recover at some point, but we are probably two or three years away." 2. Introduction In February 2011, the Obama administration issued “Reforming America’s Housing Finance Market” (Reforming America’s Housing Finance Market – A Report To Congress, accessed 8 May, 2011). The extensive ranging and significant study was motivated by the view that: “The housing finance system must be reformed. It is the vital link to sustainable home ownership and rental options for millions of Americans, and it is central to our nation’s economy. We allowed its flaws to go unchecked for too long, contributing to a financial collapse that strained families, decimated communities, and pushed the economy into the worst recession since the Great Depression” (p.31). Since the housing market in the US is undergoing a period of depression even now, an analysis of the article with regard to aggregate demand and aggregate supply of the housing market is discussed in this report. Apart from this all other relevant areas of macro economics will be discussed with a summary at the end of the report as a conclusion will be added. 3.1 Macroeconomics According to Gwartney et al, (2006) macroeconomics is a part of the study of economics which centers on the aggregate economic system. Macroeconomics examines the economy at a national/global level and is related with the economy as a whole. According to Susan Wachter et al (2010), "Housing, which usually leads us out of recession and into recovery, will be a lagging indicator this time. Consumers will look to the health of the whole economy to decide whether to make a home purchase or not." 3.2 Analysis of macroeconomics with regard to housing situation in the US: CASE-SHILLER HOUSE PRICE INDEXES U.S. Home Price Index Quarterly 2000-2010 Source: Bloomberg The above graph shows that the rising fall of the house prices nationwide has exceeded 32% from the 2006 peak, as measured by the Case- Shiller House Price Index (chart). Almost five million households have lost their homes through legal proceedings or short selling. With the exclusion of house prices and legal proceeding, the majority housing-linked standards have reached the bottom, but a healthy revival is doubtful (Bloomberg). The fundamental issue with the residential housing market is linked to a constant imbalance between supply and demand. The basic demand for housing stays gloomy while the supply of unsold homes stays disproportionate. The result is evident as sales of homes are Home sales are dormant, new construction stays exceptionally low, and nationwide house prices carry on to weaken. The demand for housing is also at a low range inspite of low-cost in most major markets. This has led to negative look at the house prices by the consumers and new house hold creation has decreased by 50%. The supply also is on the decrease because there were massive number of houses built during 2000-2007 and record number of foreclosures (Bloomberg). 3.3 Aggregate demand curves Source: McConnell, 2010 Aggregate demand curve depicts the quantities of real GDP that purchasers jointly want to buy at each potential price level. The correlation between the price level and the quantity of real GDP required is reverse or negative. In reality with every increase in the real GDP demanded decreases while every decrease in price the real GDP increases. In the above figure the downward-sloping aggregate demand curve AD suggests a negative correlation between price and the quantity of output bought (McConnell, 2010). Changes in Aggregate Demand A shift in the level of the price changes the aggregate spending thus resulting in the change of real GDP provided other factors remain the same. But if there is a change in other factors then the complete aggregate demand cure will change and these other factors is known as determinatives of cumulative demand (McConnell, 2010). Source: McConnell, 2010 From the figure it can be seen that the curve AD1 has changed to AD2 proving that there is an increase in the aggregate demand while the curve AD3 depicts the reverse meaning that there is a decrease in aggregate demand (McConnell, 2010). 3.5 Aggregate Supply Aggregate supply curve shows the connection between the price level of production and the quantity of real domestic yield that firms in the economic system make. This bond is reliant on the time perspective and how fast output costs and input costs can alter. There are three time perspectives as follows (McConnell, 2010): i The input prices and the prices of the products are fixed when the time period is in the immediate short run. ii When production prices changes but costs of input are fixed then it is a example of short run. iii When both the prices of the input and the costs of output can change then it is in the long run. Aggregate Supply in the Immediate Short Run Source: McConnell, 2010 The immediate-short-run collective supply curve ASISR is a straight line, as shown in the figure. It shows that the real output changes and the price level P1 remains the same. This price level is computed with the help of all individual prices which are fixed by different firms in the economic system. Its flat shape means that the entire quantity of production provided in the economy is reliant directly on the degree of expenditure that ensues at price level P1. When the total amount spent is less at P1 then the firms will also supply less so that it can be matched. But if the total spending is more at the same level of P1 then the firms will also supply more quantity to match the expenditure. The quantity of production that ensues may be more than or less than the economy’s full-employment output level GDPf (McConnell, 2010). Aggregate Supply in the Short Run proves that the prices of the output are not fixed and are prone to changes whereas the prices of the input are fixed. Source: McConnell, 2010 In the above figure the short-run aggregate supply curve AS inclines upward since the price of input is fixed and any shift in the price level will either increase or decrease the profits of the firm (McConnell, 2010). Aggregate Supply in the Long Run means that the prices of all the inputs will be flexible and none will be fixed. Reliant on the kind of firm the long run may be from a pair of weeks to a number of years in the future (McConnell, 2010). Source: McConnell, 2010 From the figure above it can be seen that the long-run aggregate supply curve ASLR is perpendicular at the economy’s complete-employment output GDPf. The vertical curve entails that in the long-term the economy will generate full-employment turnout level irrespective of the price level (McConnell, 2010). Source: McConnell, 2010 Source: Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia From the above graph it is clear that in long-run equilibrium, the aggregate demand and short-run aggregate supply curves intersect at a point along the long-run aggregate supply curve (Hubbard et.al. 2010). Using fiscal policy to influence aggregate demand Expansionary fiscal policy The goal of expansionary fiscal policy is to increase aggregate demand by more than it would have increased without policy. The aim is to shift the AD curve further to the right. This shift is appropriate when the economy is in equilibrium below full-employment, eg: a recession (Hubbard et.al. 2010). This is depicted in the following graph: Contractionary fiscal policy: This policy involves decreasing government purchases and/or increasing taxes. With every decrease in government leverages or a boost in taxes will decrease the rate of increase in aggregate demand, to lessen the rate of inflation. This situation is suitable when the economy is over full employment equilibrium and the rate of inflation is high (Hubbard et.al. 2010). The following graph shows this The relentless failing of the labour market will carry on counting on households finances. In spite of the pick up in a range of measures of action, there has been little matching speeding up in the rate of employment growth. This is evident from the above graph. In the article Paul Dales, US economist at Capital Economics states that “It will recover at some point, but we are probably two or three years away. High unemployment, the tightening of lending criteria by the banks and the fact that so many homeowners are in negative equity have undermined the foundations of the housing market, he says. "The top end of the market has done OK, but the bottom end is doing badly and I wouldnt be surprised if the top end sees a further drop off too." This is relevant by the graph shown below. Lots of ups and downs are depicted in the graph. The banks lending policies has been tightened and the interest rates are also high which has brought a slump in the demand for houses. Source: (http://www.census.gov/const/uspriceann.pdf, accessed 8 May, 2011). Conclusion: Since the housing bubble was not forced by supply and demand, excess supply due to overbuilding and less demand for houses due to retirement of baby boomers and selling. Prices with regard to the housing market actually at present entirely are a function of the banks willingness and ability to lend. The confidence of the home builders in the US is even now very low. The Index of the Housing Market remains unaltered at 13. Due to government tax credit being now expired, the index attained its peak and the unemployment remains at its high of 9.6%. Also since the continued competition from precluded and hard-pressed properties are below the cost of construction, home builders carry on to function in a testing environ continued competition from precluded and hard-pressed properties are below the cost of construction, home builders carry on to function in a testing environ. The same is depicted in the following graph. Source: World Bank DEC Prospects Group and Thomson Reuters. Reference: 1. Bloomberg.com Business & Financial News, 2011. 2. Economics: Private & Public Choice, (2006),11th Ed.; Gwartney, Stroup, Sobel, and MacPherson; Thomson South-Western, 3. Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia 4. McConnell, 2010 Aggregate Demand and Aggregate Supply McGraw-hill Publications (225-237) 5. Pyndick and Rubinfeld, 2008, Microeconomics, 7th Ed.Prentice Hall 6. Robert F. DeLucia, (2001), CFA, Consulting Economist, U.S. housing market: outlook and analysis of current trends, 7. Susan M Wachter, Andrey Pavlov (2010), Subprime Lending and Real Estate Prices, Real Estate Economics Web Sites Accessed 8. http://www.treasury.gov/initiatives/Documents/Reforming%20Americas%20Housing%20Finance%20Market.pdf (accessed 8 May, 2011). 9. http://www.capitaleconomics.com/us-housing/the-us-housing-market-analyst/ another-year-of-falling-prices. PDF(accessed 8 May, 2011). 10. http://www.census.gov/const/uspriceann.pdf (accessed 8 May, 2011). 11. World Bank DEC Prospects Group and Thomson Reuters, 2010 Read More