With the New Year and the US recovery soon to be record-breaking in duration, many are asking when the next recession is likely to come and what will cause it. While none of us has a crystal ball that gives a clear view of the future, there are a few things we can say.
First, and most importantly, the next recession will not look like the last recession. The last recession was caused by the collapse of a massive housing bubble that had been the driving force in the previous recovery. While economists like to pretend this was an unforeseeable event, that is not true.
There was an unprecedented run-up in nationwide house prices. It was clear that this was not being driven by the fundamentals of the housing market, as there was no remotely corresponding increase in rents, and vacancy rates were hitting record levels.
Furthermore, it was easy to see the housing bubble was driving the economy. Residential construction was hitting record shares of GDP, more than two full percentage points above its long-term average of 4.0 percent of GDP.
The wealth created by the bubble was also leading to a consumption boom, as people spent based on the new equity created by the run-up in the price of their home. This was also easy to see in the data, as the ratio of consumption-to-income hit record levels.
This history is important to review because many analysts are looking for the next recession to be a replay of the 2008 crash. If we pretend that the bursting of the housing bubble and subsequent downturn was an unforeseeable event, then there could be other unforeseen events that will sink the economy. For this reason, it is necessary to point out that the 2008 collapse was entirely foreseeable, economists just ignored the evidence that was visible to anyone who examined the economy with open eyes.
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