The Economy and Housing in the 198Os

by Dr. Randall J. Pozdena* Economist Federal Reserve Bank ol'San Francisco

He Early

1980s will be a critical juncture f,or the American econ- omy and its housing industry. The condition of the economy in 1980 has largely been preordained by the policies of the recent past, but the policies pursued in 1980 will determine whether the economy continues in its ten-year-old pattern of stagflation or settles down into a more acceptable scenario of steady growth and low rates of interest and inflation.

The unexpectedly high rate of money supply growth in the April to October period of 1979 very likely snuffed out the incipient recession of 1979, but that effect will be temporary and the recession should begin to develop more fully in the first quarter of 1980 or early in the second quarter. It may be summertime or later before major increases in the jobless rate are observed.

The high short-term interest rates that followed the Federal Reserve Board's policy changes on October 6. 1979. should begin to abate early in 1980. These rates should fall sharply once credit demand begins to slacken. Shortterm rates of 8ol, by year-end 1980 are not impossible. Long-term rates typically fall later and more slowly than short-term rates.

However, if the markets sense that ground is really being gained in the fight against inflation as a result of the new direction of Fed policy, Iong rates may tumble more rapidly than their traditional pattern would predict.

Housing will be weakened by the recession and the relatively high costs of long-term credit. However, recent innovations in the sources of funds for lenders in the housins market will protect the supply oT credit from the exaggerated reductions we have observed in the oast.

On the demand side. as long as inflation expectations remain strong, consumer tolerance of high interest rates will be somewhat stronger than in the past. The persistence ol these expectat ions would be a mixed blessing, however. because it would indicate that a much deeper or prolonged recession may be necessary to successfully combat inflation in the long run-

The policy choice which our economy faces going into the decade of the Eighties is a simple one. If, in an attempt to protect the economy from the effects of a recession, we prematurely apply fiscal or monetary stimulus to the economy, inflationary forces will accelerate. Inflation rates of 20rZr25t\t are conceivable in the next cycle and the ultimate control of inflation may escape our grasp.

A more hopeful scenario would be one involving a policy of steady

Story at a Glance

A strong decade... short term money rates of 8o/o possible by year-end 198O. inflation rates of 2Oo/o-25o/o "conceiYable in the next cycle".. early 198Os a critical juncture for U.S. economy and housing.

and modest money growth and movement toward a policy of balance in the federal budget. These policies would delay recovery from the recession that is at hand. but they are the only ones which have the prospect of reducing inflation in the long-term and providing the foundation for sound economic growth.

If we pursue this latter path, the weak conditions of 1980 will sradually give way to an econdmic environment that is better for housing in many ways. On the construction-cost side, speculative appreciation in land values should slow as investors' demand for "inflation-

(Please turn to page I 1 1 )