Recessions Trump Low Interest Rates For Car And Home Sales

Economists are worried about recession, with an average estimate of 45% probability that one will begin in the next 12 months, according to the Wall Street Journal’s recent survey. The Federal Reserve would certainly cut interest rates if that happened, as emphasized by Chair Jerome Powell’s recent comments that data will drive the Fed’s upcoming decisions.

Interest-sensitive business might be wondering if a recession would actually help them by lowering interest rates. Stimulating spending in the interest-sensitive parts of the economy is a key element of monetary policy in a recession. The historical data are disappointing, though. Spending drops in recessions, even in interest-sensitive sectors. Looking at two key sectors in detail, it’s clear that business contingency planning should focus on the downside risk of recession rather than the upside from falling interest rates.

This conclusion is driven by studying two sectors of the economy: car sales, new home sales and private non-residential construction.

Many of the country’s recessions were triggered by rising interest rates as the Fed tried to fight inflation. Those downturns occurred in 1970, 1973-75, 1980 and 1981-82. In all of these cases, car sales and home sales had dropped well before the recessions. In fact, the interest-sensitive sectors pulled the economy down in these slumps. When the Fed cut interest rates to fight those recessions, sales in both sectors revived partially, but the recessions themselves hurt activity.

Two of the more recent recessions offer better lessons. Car sales began to fall in late 1989 just after interest rates hit their peak for that cycle. Sales slumped more even as interest rates fell, then slowly regained ground as the downturn fell farther into the past. The recession of 1990 played a larger role than interest rates movements.

The economy went into recession again in 2001, frequently attributed to the end of Y2K spending and the dot-com bust. Auto sales were roughly flat even though the Fed cut its benchmark interest rate from 6.5% to 1.75%. That enabled automakers to offer zero percent financing (making up the difference between market interest and zero). There was no real decline in sales in this recession, possibly because of that sharp interest rate cut. But certainly car dealers had no boost to sales from the lower interest rates.

New home sales in these two recessions did improve as interest rates fell, but the recession still had an impact. The data show that home sales would have been better if the recession had not occurred.

The “Great Recession” of 2008-09 was very severe. Interest were cut to near zero percent (for short maturities). But new automobile sales took four years to regain their pre-recession level even with interest rates of approximately nil.

Home sales in this era do not tell a recession-and-interest rate story. Rather, the boom in new construction in the years preceding the recession swamped the market with excess housing. It took years before new home sales recovered. In fact, they have not yet regained the peak level of 2005 despite 20 years having elapsed.

The most recent recession occurred with the pandemic. The economy peaked in February 2020, then hit its trough just two months later. Auto sales dropped sharply in the lock-down days, then recovered with some make-up sales. The Fed cut interest rates sharply in the pandemic, but sales remained low for two years. Supply chain disruptions, including computer chip shortages, may explain some limitation of sales.

New home sales did surge with low interest rates, rising well above the pre-pandemic trend line. There’s no doubt that low financing costs helped sales. Many apartment renters who had wanted to buy a house calculated their borrowing cost at the low interest rates and went shopping well before they otherwise would have been able to at the old interest rates.

The weight of evidence, despite the post-pandemic home sales rally, is that recessions trump low interest rates. Business plans should certainly take into account the mitigating effects of lower interest rates during recessions, but there’s no justification for anticipating higher sales, not even in the most interest-sensitive parts of the economy.