The boom in real estate prices during the early 2000s and the subsequent bust were key factors underlying the recessions in the United States and Europe.Financial crises ; Recessions ; Housing - Prices

Adrian Peralta-Alva

English

Research Papers in Economics

Economic SYNOPSES
short essays and reports on the economic issues of the day
2011 ■ Number 35
T
he boom in real estate prices during the early 2000s
and the subsequent bust were key factors underlying
the recessions in the United States and Europe. How
could housing prices affect the entire economy so drastically?
When the price of a good or service goes up, people usually
supply more of it. In this case, higher house prices led con-
struction firms to build more houses. Once housing prices
crashed, no one wanted to build houses anymore. This
directly reduced the most common measure of output:
gross domestic product (GDP). A logical expectation might
be that the resources—workers and capital equipment—
that had been producing houses would switch to producing
other things that consumers did want (e.g., using those
resources to build roads, provide health care, or make
breakfast cereal). However, because construction workers
cannot transfer their skills quickly or without cost to pro-
duce other goods, unemployment in the construction sector
rose, directly reducing aggregate employment.
In this essay, I use industry-level data from the United
States and European countries to estimate the direct nega-
tive effect of the construction sector crash on GDP and
aggregate employment. The results are summarized in two
charts. The chart on the left shows the direct effect of the
changes in construction sector employment from 2008 to
2010 versus total employment for 31 different countries.
The change in construction sector employment is the con-
struction sector’s proportion of 2008 employment times the
percentage change in this sector’s employment from 2008
to 2010. This chart also contains a statistically fitted line
that illustrates the strong relation between the two variables.
The fitted line implies that declines in construction employ-
ment can directly account for about half of the observed
changes in total employment.
The chart on the right shows a similar analysis for the
direct effects of construction sector output declines and
declines in total GDP. The statistically fitted relation between
these two variables is still positive, but a little weaker as
Construction and the Great Recession
Adrian Peralta-Alva, Senior Economist
NOTE:  AT, Austria; BE, Belgium; BG, Bulgaria; CH, Switzerland; CY, Cyprus; CZ, Czech Republic; DE, Germany; DK, Denmark; EA15, euro area (15 countries); EE, Estonia; ES, Spain; EU15, 
European Union (15 countries); FI, Finland; FR, France; GR, Greece; HU, Hungary; IE, Ireland; IS, Iceland; IT, Italy; LT, Lithuania; LU, Luxembourg; LV, Latvia; MT, Malta; NL, Netherlands; 
NO, Norway; PL, Poland; PT, Portugal; RO, Romania; SE, Sweden; SI, Slovenia; SK, Slovakia; TR, Turkey; UK, United Kingdom.
Employment 
–25
–20
–15
–10
–5
0
5
10
15
–7 –6 –5 –4 –3 –2 –1 0 1 2
Percentage Change in Employment in Construction Sector * Share of Total Employment
Percentage Change in Total Employment
Relation Between Construction Sector and 31 Countries (2008 vs. 2010)
IS
UK
FI
BG
CZ
EU15
NL
BE
DK
USA
ES
PT
LV
EE
IE
LU
LT
MT PL
HU
EA15
GDP Growth 
y = 2.3383x – 0.1313 (R2 = 0.73415)
–25
–20
–15
–10
–5
0
5
–8 –7 –6 –5 –4 –3 -2 –1 0 1
Percentage Change in Value Added of the Construction Sector * Share of GDP
Percentage Change in GDP
IS
EE
IE
RO
TR
UK
SE
NO
FI
SI
CH
BG
CZ
GR
EU15
DE
NL
SK
BE
DK
USA ES
PT
GY y = 2.2747x – 4.0017 (R2 = 0.35403)
IT
DE
FR RO
HR
PL HU
TR TR
AT
IT
EA15
The boom in real estate prices 
during the early 2000s and the 
subsequent bust were key factors
underlying the recessions in the
United States and Europe.the dots do not follow the line as closely. This weaker rela-
tion may be explained, at least in part, by the fact that the
share of total employment in the construction sector is
considerably higher than its share in GDP.
These findings suggest that the direct impact of the
crash of the construction sector is very important in under-
standing the changes in U.S. and European GDP and
employment, but it is not the whole story. In addition to
the direct effect of the decline in the construction sector
on GDP and employment, the housing bust also indirectly
affects the economy through other economic sectors. A
construction slump reduces construction firm purchases
from other sectors, which reduces employment and pur-
chases in those sectors. These interconnections amplify
the direct impact of the negative shock to the construction
sector on GDP and employment. Further work is needed
to better understand the forces driving the persistently high
unemployment rate and lackluster economic growth since
the recession. ■
Economic SYNOPSES Federal Reserve Bank of St. Louis      2
research.stlouisfed.org
Posted on November 8, 2011
Views expressed do not necessarily reflect official positions of the Federal Reserve System.

Construction and the Great Recession

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Construction and the Great Recession

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