Abstract

This paper considers dynamics in the reversal of booms in the housing market.
We analyze three related mechanisms which govern the propagation of changes in the housing
market throughout the rest of an advanced economy: wealth effects, income effects, and effects
through financial markets. As the decade-long boom in the US housing market unwinds, we
anticipate that there will be small wealth effects transmitted to the economy, but there will be
large income effects affecting the rest of the economy and substantial financial market effects.
If the current decline in housing starts and residential investment echoes the declines of the
last three housing downturns, we estimate that gross national product (GNP) growth will be
reduced by close to 3 per cent. Beyond the decline in housing investment, the recent turmoil in
financial markets makes a recession induced by housing market conditions increasingly likely.

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