Final answer:
Housing is very sensitive to interest rate changes, which are cyclical, affecting housing demand and prices. The leverage cycle magnifies these effects during economic booms and downturns, as seen in the mid-2000s housing bubble. Central banks may need to consider these factors in monetary policy.
Step-by-step explanation:
Edward Leamer's assertion that "housing is the business cycle" refers to the significant impact that housing market fluctuations can have on the broader economy. The correct response to the student's question is that housing is very sensitive to interest rate changes, which are cyclical (option d). This is because when interest rates are low, borrowing to finance home purchases is more affordable, which increases demand for housing and can lead to higher housing prices. Conversely, when interest rates rise, borrowing costs increase, demand for housing can decrease, and housing prices may fall.
The leverage cycle plays an important role in this process. During economic growth periods, increased lending leads to higher asset prices, such as housing. However, when economic conditions worsen, lending decreases, and asset prices may fall rapidly, worsening the downturn.
This is further illustrated by the history of housing prices, especially during the period known as the housing bubble in the mid-2000s, when housing prices increased at nearly double the historical rate. When the bubble burst, the associated decrease in asset values contributed to the recession that started in 2007. Central banks are now considering the implications of asset price bubbles and leverage cycles on monetary policy.