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April 7, 1980

Consumer Behavior
and the Saving Concept
An uncertainty

that

clouds

most

fore-

casts is the marked change in consumer
spending-saving
behavior.
Since the early
1950s, consumers
have saved slightly more
than 6 percent from their disposable income.
During the period of rapid inflation between
1965 and 1975, consumers stepped up their
rate of personal saving to about 7 percent of
income after taxes.
Consumers have responded much differently to inflation in recent years than in the
past. Since 1977, and especially since late
1979, the saving rate trended
downward,
falling to 3.4 percent by year-end 1979, the
lowest since the early 1950s. Reasons for
this departure
from historical averages are
not clear. It is also unclear whether the sharp
decline in the saving rate is an aberration or
a new norm based upon widespread expectations of continued
high rates of inflation.
The premature
forecasts of a recession in
1979 were based largely on the expectation
that consumers
would step up saving from
income,
simply
because
recent
rates of
personal saving have been low by historical
standards.
Instead,
consumers
cut
back
saving in late 1979, and preliminary
information for early 1980 does not yet suggest a
resumption
of more normal spending-saving
patterns.
Some
of the problems
inherent
in
interpreting
saving behavior are due to the
difficulty
in measuring
personal
saving.
There are two commonly
used concepts of
saving, one that is prepared
by the U.S.
Department
of Commerce
and the other
prepared by the Board of Governors of the
Federal
Reserve
System.
John
Gorman,
assistant
chief
of the National
Income
Division of the U.S. Department
of Commerce, told the Fourth District economists
that both concepts are conceptually
similar

and both have the defect of being derived
from residual computations.f The saving
rate concept
in the national
income and
product accounts is measured as the residual
between disposable
income and total consumer outlays. Income not recorded as being
spent on goods and services, interest payments, and remittances
abroad is assigned
to the saving estimate. The saving concept
in the flow of funds is a net worth concept
that attempts
to measure the changes in
acquisition
of assets less liabilities during a
given period. Here, too, allocation of much
of the assets and liabilities to the household
sector
is based on residual calculations.
Neither concept attempts to measure changes
in the value of assets held by households,
which in recent times have been an important
support for consumer spending. Gorman also
explained that, while there are no conceptual
differences
between the two measures, differences in estimates are sometimes
significant. In the fourth
quarter
of 1979, for
example, the flow of funds concept of saving
showed an increase in personal saving, while
the national income account concept showed
a decrease. Also, the level and rate of personal saving according to the flow of funds
measure are considerably
higher than the
national
income
measure.
Despite
divergences between
these two measures,
both
have shown a declining trend since 1977.
While Gorman viewed this trend as disturbing, he cautioned that the quality of the data
has deteriorated
in recent years. Furthermore, unreported
income may be understating the level and rate of personal saving.
On the product
side of national
income

2.

Although
these two
concepts
are measured
differently,
they may be considered
conceptually
similar because personal saving may include financial assets, such as cash and deposits,
as well as physical assets, such as net acquisition
of real property.

accounts, for example, income can be understated by as much as 'h of 1 percent. Similarly, income can be understated
because of
underreporting.
Nevertheless,
economists
have generally
tended to accept published data that show a
historically
low saving rate as a signal of consumer behavior.
It is uncertain
when or
whether the saving rate will revert to historical
averages. The median forecast of Fourth District round-table
economists
incorporates
a
saving-rate assumption
of about 3.5 percent
in the first half of 1980,4 percent in the third
quarter, and 4.5 percent in the fourth quarter.
Some, however, expect that consumers will
promptly
begin to save more from their
income and spend less in the first half in
response
to heightened
uncertainties
and
growing reluctance
to rely on saving substitutes to maintain
spending.
An economist
commented
that consumers have indeed cut
back on real spending for the past several
quarters, trying simply to maintain their past
standards of living; consumers are unlikely to
commit themselves to purchases of long-term
assets, at least until real income improves.

Defense Spending
Another economic uncertainty
discussed
by the round-table
economists concerns the
rearmament
program. Some economists have
incorporated
higher defense spending into
their outlooks for 1980 and 1981 than that
proposed
by the administration.
Increased
defense spending was expected to moderate
the recession in 1980. Despite the administration's proposed boost in military spending,
the military budget for fiscal year (FY) 1980
and FY 1981-relative
to GNP or to total
federal expenditures-is
virtually unchanqed
from 1970. Congress, therefore,
may accelerate defense spending
by the administration
budget.

beyond that proposed
in the January
1980

Overall, however,
the Fourth
District
economists do not expect much acceleration
in defense spending this year. The median
forecast for defense spending shews a 12.3
percent gain between the fourth quarter of
1979 and the fourth quarter of 1980, hardly
different from the change in the comparable
year-earlier
period. Moreover, it was noted
that both the relatively small magnitudes of
defense spending and the long lags between
the budget proposal and the actual economic
impact
strongly
suggest
that
the 1980

ECONOMIC
COMMENTARY

outlook for economic activity would not be
affected
much
by
accelerated
defense
spending. The lags between contract awards
and deliveries, for example, are as much as
five quarters;
for sophisticated
equipment
the lags are substantially
longer. Lags apparently have lengthened
because of shortages
and bottlenecks.
One defense
contractor
reported that shortages of aluminum forgings
have lengthened
lead times from 34 to 36
weeks to as many as 74 to 76 weeks; lead
times
on micro-processor
circuits
have
averaged
18 to 24 months.
Moreover,
it
would be difficult to expand production
in
the short run because of shortages of skilled
and technical
workers, especially engineers
and scientists;
there is also a shortage of
suppliers for some types of products,
including
forgings,
castings,
and electronic
parts and equipment. The defense contractor
expected
that
supplements
to the
FY
1981
budget
would
boost
real defense
spending for FY 1981 by 4 to 4Y2 percent in
real terms, rather than the 3Y2 percent increase proposed

by the administration.

The views contained herein are not necessarily
those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the
Federal Reserve System.

In this issue:

Reappraising the
Economic .Outlook for 1980
\

Research

Department

Federal Reserve Bank of Cleveland
Post Office Box 6387
Cleveland. Ohio 44101

BULK RATE
U.S~ Postage Paid
Cleveland, OH
Permit No. 385

Reappraising the Economic Outlook for 1980
Twenty-eight economists met at the Federal Reserve Bank of Cleveland early in March to
discuss the economy. This Economic Commentary
reviews the appraisal of the economic
outlook that emerged from that meeting.
A rapid chain of events since late January has
added uncertainties
to an already uncertain
economic
outlook
for 1980. Among these
developments
are the stronger than expected
pace of economic activity at the beginning
of the year, the acceleration
in consumer
and producer prices, and the administration's
proposed
budget
that originally
showed
sizable deficits for fiscal years 1980 and
1981. The perception
in domestic financial
markets that fiscal policies are incompatible
with an anti-inflation
objective has crippled
equity and bond markets,
and has helped
boost short-term
interest rates 200 to 400
basis points
between
mid-February
and
mid-March. The effects of the rapid run up
in interest rates on spending decisions are
unknown, as are the effects of the latest set
of anti-inflation
measures announced
in midMarch.

Fourth District Economists
Round Table Forecasts
Against

this

background

of rapid

eco-

nomic changes,
forecasters
have adjusted
their economic
and financial outlooks
for
1980, and further
adjustments
now seem
likely.
The
Fourth
District
Economists
Round Table
appraise
the
developments

met on March 7, 1980, to
economic
outlook,
while
described
above were still

unfolding.
Although the round-table
economists
revised upward
their outlook
for
inflation
and output
in 1980 from their
forecasts at a similar meeting last November,
they held to their earlier view that a recession
would be under way in early 1980.

The round-table
forecast
of recession
last November was dominated
by a view of
weakening
consumption
expenditures,
led
by an upward shift in consumer saving from
a 30-year low in the fourth quarter of 1979.
At that meeting the recession was expected
to begin in the final quarter of 1979 and to
extend
into the third quarter
of 1980.
Measured
between
peak
and trough,
a
contraction
of 2.2 percent was foreseen in
real GNP, somewhat
less than the average
decline of six recessions in the post-World
War II period.
Economists
at the March 1980 round
table still expected a recession in 1980, but
one that would be milder than anticipated
last November.
decline about
trough,

the

Real GNP is now expected to
1 percent between peak and
same

as the

relatively

mild

recessions in 1960-1961
and 1969- 1970.1
All but a few of the round-table economists
expected
a recession to last about three
quarters. The issues that divided the economists concerned the timing and depth of the
recession. Of the 28 economists who attended
the round table, 15 forecast a slight decline
in real GNP in the first quarter of 1980;
most of the remaining economists forecast a
recession that would get under way in the
second
quarter.
The median
round-table
forecast
showed
annual
rates of decline
in real GNP of 0.2 percent in the first quarter,

in the fi rst quarter

Table 1

of 1981.

be as weak as expected last November.
Nowhere is the recession more evident
than in residential construction,
which has
been weakening
in recent months. Housing

Expectations

Median Forecasts of Changes in GNP and Related lterns"

1979

Actual

1980

Forecast

1979

Iva

la

lIa

1980

lila

Change in levels, billions of dollars,
Gross national

(GNP)

Gross private domestic
investment
Nonresidential
fixed
investment
Residential construction
Changes in business
inventories
Net exports
Government

1981
la

saar

purchases

241.8

215.9

62.9

56.1

34.4

44.0

64.7

77.0

159.2

169.9

52.6

45.8

30.0

39.3

39.7

41.0

35.7

-2.1

-4.8

-1.7

-1.2

-4.3

4.1

15.6

33.5
6.2

19.1
-10.8

5.8
-6.7

3.0
-6.4

3.5

0.6

-4.0

1.7

3.1
7.4

-3.8

-14.7

-7.8

-1.3

-0.5

-3.7

0.2

4.9

-3.8

-8.2

12.5

-0.5

1.2

0.0

-0.7

40.8

54.9

23.4

10.4

12.5

12.2

15.4

12.6

10.4

12.1
9.3
2.5
6.4

2.4

Percent
GNP, current dollars
Implicit price deflator
GNP, constant dollars
Industrial

Iva

6.1

product

Personal consumption
expenditures

production

11.4

9.1

changes,
9.4

rate, percent

1.0

annual

rates

7.1
8.8

2.3

9.1
-0.2

10.9
8.6
2.1

10.0
-0.2

5.6
9.2
-2.8

-1.6

8.8
0.5

4.1

-1.8

-0.3

-0.5

-5.8

-5.2

0.7

8.8

Absolute
Unemployment

1. Since the March 7 meeting, several of the economists have revised downward their forecasts
of real GNP to show a decline of about 2.5 to
3.0 percent between the fourth quarter of 1979
and the third quarter of 1980.

of a milder recession stemmed largely from
a belief that consumer
spending would not

2.8 percent in the second, and 1.6 percent in
the third (see table 1). The beginning of an
upturn in business activity was foreseen in the
final quarter of the year, followed by a 2.5
percent annual rate of expansion in real GNP

6.0

6.9

5.9

6.3

levels
6.8

7.2

7.5

7.4

a. Median forecasts are based on individual forecasts of the Fourth District Economists Round Table;
they do not represent forecasts of the Federal ReserveBank of Cleveland or of the Board of Governors
of the Federal ReserveSystem.
SOURCE:

Fourth District Economists Round Table, Federal ReserveBank of Cleveland, March 7, 1980.

starts have been declining since early 1978.
From March 1979 until September
1979,
new housing starts ranged between an annual
rate of 1.8 to 1.9 million units. In February
1980, housing starts fell to an annual rate of
1.3 mi Ilion units; housing starts plummeted
further in March to an annual rate of 1.0
million units. Sales of new and used houses
have slumped,
leading to a softening
in
home-purchase
prices. One of the Fourth
District economists
suggested that housing
starts would continue
to decline during the
balance of 1980. Several reasons were given
to support this view. The sharp run up in
interest rates affects both mortgage lenders
and buyers. Thrift institutions
could find it
increasingly
difficult
to attract
and hold
deposits, especially since the ceiling rate of
12 percent was established
for the 2Y2-year
money-market
certificate effective March 1,
1980.
There
is some doubt,
moreover,
about the willingness of some thrift institutions to issue six-month savings certificates
because of severely squeezed profit margins.
Demand for mortgage
loans at 13 percent
was sa id to be soft, and at 15 to 17 percent
demand would weaken even more. Moreover,
investment psychology in relation to housing
appears to have weakened.
In recent years
investors
perceived
rates of return
from
housing in a range of 20 to 30 percent, but
softness in house prices and the inability to
sell homes have reduced the expected return.
In addition,
yields on competing
financial
instruments were 15 percent or more.
Fourth District economists expect newcar sales to
forecast of
sales at 9.7
10.6 million

decline again in 1980. The median
seven economists
shows new-car
million units, compared with the
sales in 1979. Sales of small cars,

both domestic
and imports, are again expected to account for a larger share of total
cars at the expense of large and intermediatesized cars.

Although
over one-half of the roundtable economists
expected the recession to
begin in the first quarter,
others doubted
that a recession would occur before the
second or third quarter of 1980. One of the
economists
pointed out that a shift away
from a recession psychology has temporarily
spurred
economic
activity,
perhaps
best
illustrated
by a turnabout
in inventory
policies. Some industries that were depleting
inventory
in late 1979 are no longer doing
so; indeed,
they
may even be building
stocks because of a shift in psychology.
At
the center of this shift is the steel industry,
for which orders picked up early in 1980 but
have since fallen. Steel economists, therefore,
have upgraded
thei r forecasts
for steel
shipments
for the first half of 1980-a
development,
however, that might contribute
to somewhat
greater
weakness
in
production
during the second half.
Skepticism over a mild recession scenario
was expressed
by some
believed that high inflation

economists
and interest

who
rates

would result in a more serious recession than
indicated
in the median forecast.
Expectations of a deeper recession, with a peak to
trough decl ine of perhaps 2.5 percent, were
based on a perception that economic policies
would tighten in order to control inflation.
The resulting
higher interest
rates would
further
weaken
interest-sensitive
markets,
such
as residential
construction.
Some
economists
acknowledged
that
the high
interest
rates and inflation of early 1980
have no parallel in previous experience and
that their implications
for economic activity
are uncertain.
The more severe recession
scenario also assumes an upward shift in the
rate of personal
saving toward
historical
relationships.
Therefore,
curtailment
in
consumer spending, as well as in residential
construction,
was seen as having cumulative
downward

effects elsewhere

in the economy.

Reappraising the Economic Outlook for 1980
Twenty-eight economists met at the Federal Reserve Bank of Cleveland early in March to
discuss the economy. This Economic Commentary
reviews the appraisal of the economic
outlook that emerged from that meeting.
A rapid chain of events since late January has
added uncertainties
to an already uncertain
economic
outlook
for 1980. Among these
developments
are the stronger than expected
pace of economic activity at the beginning
of the year, the acceleration
in consumer
and producer prices, and the administration's
proposed
budget
that originally
showed
sizable deficits for fiscal years 1980 and
1981. The perception
in domestic financial
markets that fiscal policies are incompatible
with an anti-inflation
objective has crippled
equity and bond markets,
and has helped
boost short-term
interest rates 200 to 400
basis points
between
mid-February
and
mid-March. The effects of the rapid run up
in interest rates on spending decisions are
unknown, as are the effects of the latest set
of anti-inflation
measures announced
in midMarch.

Fourth District Economists
Round Table Forecasts
Against

this

background

of rapid

eco-

nomic changes,
forecasters
have adjusted
their economic
and financial outlooks
for
1980, and further
adjustments
now seem
likely.
The
Fourth
District
Economists
Round Table
appraise
the
developments

met on March 7, 1980, to
economic
outlook,
while
described
above were still

unfolding.
Although the round-table
economists
revised upward
their outlook
for
inflation
and output
in 1980 from their
forecasts at a similar meeting last November,
they held to their earlier view that a recession
would be under way in early 1980.

The round-table
forecast
of recession
last November was dominated
by a view of
weakening
consumption
expenditures,
led
by an upward shift in consumer saving from
a 30-year low in the fourth quarter of 1979.
At that meeting the recession was expected
to begin in the final quarter of 1979 and to
extend
into the third quarter
of 1980.
Measured
between
peak
and trough,
a
contraction
of 2.2 percent was foreseen in
real GNP, somewhat
less than the average
decline of six recessions in the post-World
War II period.
Economists
at the March 1980 round
table still expected a recession in 1980, but
one that would be milder than anticipated
last November.
decline about
trough,

the

Real GNP is now expected to
1 percent between peak and
same

as the

relatively

mild

recessions in 1960-1961
and 1969- 1970.1
All but a few of the round-table economists
expected
a recession to last about three
quarters. The issues that divided the economists concerned the timing and depth of the
recession. Of the 28 economists who attended
the round table, 15 forecast a slight decline
in real GNP in the first quarter of 1980;
most of the remaining economists forecast a
recession that would get under way in the
second
quarter.
The median
round-table
forecast
showed
annual
rates of decline
in real GNP of 0.2 percent in the first quarter,

in the fi rst quarter

Table 1

of 1981.

be as weak as expected last November.
Nowhere is the recession more evident
than in residential construction,
which has
been weakening
in recent months. Housing

Expectations

Median Forecasts of Changes in GNP and Related lterns"

1979

Actual

1980

Forecast

1979

Iva

la

lIa

1980

lila

Change in levels, billions of dollars,
Gross national

(GNP)

Gross private domestic
investment
Nonresidential
fixed
investment
Residential construction
Changes in business
inventories
Net exports
Government

1981
la

saar

purchases

241.8

215.9

62.9

56.1

34.4

44.0

64.7

77.0

159.2

169.9

52.6

45.8

30.0

39.3

39.7

41.0

35.7

-2.1

-4.8

-1.7

-1.2

-4.3

4.1

15.6

33.5
6.2

19.1
-10.8

5.8
-6.7

3.0
-6.4

3.5

0.6

-4.0

1.7

3.1
7.4

-3.8

-14.7

-7.8

-1.3

-0.5

-3.7

0.2

4.9

-3.8

-8.2

12.5

-0.5

1.2

0.0

-0.7

40.8

54.9

23.4

10.4

12.5

12.2

15.4

12.6

10.4

12.1
9.3
2.5
6.4

2.4

Percent
GNP, current dollars
Implicit price deflator
GNP, constant dollars
Industrial

Iva

6.1

product

Personal consumption
expenditures

production

11.4

9.1

changes,
9.4

rate, percent

1.0

annual

rates

7.1
8.8

2.3

9.1
-0.2

10.9
8.6
2.1

10.0
-0.2

5.6
9.2
-2.8

-1.6

8.8
0.5

4.1

-1.8

-0.3

-0.5

-5.8

-5.2

0.7

8.8

Absolute
Unemployment

1. Since the March 7 meeting, several of the economists have revised downward their forecasts
of real GNP to show a decline of about 2.5 to
3.0 percent between the fourth quarter of 1979
and the third quarter of 1980.

of a milder recession stemmed largely from
a belief that consumer
spending would not

2.8 percent in the second, and 1.6 percent in
the third (see table 1). The beginning of an
upturn in business activity was foreseen in the
final quarter of the year, followed by a 2.5
percent annual rate of expansion in real GNP

6.0

6.9

5.9

6.3

levels
6.8

7.2

7.5

7.4

a. Median forecasts are based on individual forecasts of the Fourth District Economists Round Table;
they do not represent forecasts of the Federal ReserveBank of Cleveland or of the Board of Governors
of the Federal ReserveSystem.
SOURCE:

Fourth District Economists Round Table, Federal ReserveBank of Cleveland, March 7, 1980.

starts have been declining since early 1978.
From March 1979 until September
1979,
new housing starts ranged between an annual
rate of 1.8 to 1.9 million units. In February
1980, housing starts fell to an annual rate of
1.3 mi Ilion units; housing starts plummeted
further in March to an annual rate of 1.0
million units. Sales of new and used houses
have slumped,
leading to a softening
in
home-purchase
prices. One of the Fourth
District economists
suggested that housing
starts would continue
to decline during the
balance of 1980. Several reasons were given
to support this view. The sharp run up in
interest rates affects both mortgage lenders
and buyers. Thrift institutions
could find it
increasingly
difficult
to attract
and hold
deposits, especially since the ceiling rate of
12 percent was established
for the 2Y2-year
money-market
certificate effective March 1,
1980.
There
is some doubt,
moreover,
about the willingness of some thrift institutions to issue six-month savings certificates
because of severely squeezed profit margins.
Demand for mortgage
loans at 13 percent
was sa id to be soft, and at 15 to 17 percent
demand would weaken even more. Moreover,
investment psychology in relation to housing
appears to have weakened.
In recent years
investors
perceived
rates of return
from
housing in a range of 20 to 30 percent, but
softness in house prices and the inability to
sell homes have reduced the expected return.
In addition,
yields on competing
financial
instruments were 15 percent or more.
Fourth District economists expect newcar sales to
forecast of
sales at 9.7
10.6 million

decline again in 1980. The median
seven economists
shows new-car
million units, compared with the
sales in 1979. Sales of small cars,

both domestic
and imports, are again expected to account for a larger share of total
cars at the expense of large and intermediatesized cars.

Although
over one-half of the roundtable economists
expected the recession to
begin in the first quarter,
others doubted
that a recession would occur before the
second or third quarter of 1980. One of the
economists
pointed out that a shift away
from a recession psychology has temporarily
spurred
economic
activity,
perhaps
best
illustrated
by a turnabout
in inventory
policies. Some industries that were depleting
inventory
in late 1979 are no longer doing
so; indeed,
they
may even be building
stocks because of a shift in psychology.
At
the center of this shift is the steel industry,
for which orders picked up early in 1980 but
have since fallen. Steel economists, therefore,
have upgraded
thei r forecasts
for steel
shipments
for the first half of 1980-a
development,
however, that might contribute
to somewhat
greater
weakness
in
production
during the second half.
Skepticism over a mild recession scenario
was expressed
by some
believed that high inflation

economists
and interest

who
rates

would result in a more serious recession than
indicated
in the median forecast.
Expectations of a deeper recession, with a peak to
trough decl ine of perhaps 2.5 percent, were
based on a perception that economic policies
would tighten in order to control inflation.
The resulting
higher interest
rates would
further
weaken
interest-sensitive
markets,
such
as residential
construction.
Some
economists
acknowledged
that
the high
interest
rates and inflation of early 1980
have no parallel in previous experience and
that their implications
for economic activity
are uncertain.
The more severe recession
scenario also assumes an upward shift in the
rate of personal
saving toward
historical
relationships.
Therefore,
curtailment
in
consumer spending, as well as in residential
construction,
was seen as having cumulative
downward

effects elsewhere

in the economy.

April 7, 1980

Consumer Behavior
and the Saving Concept
An uncertainty

that

clouds

most

fore-

casts is the marked change in consumer
spending-saving
behavior.
Since the early
1950s, consumers
have saved slightly more
than 6 percent from their disposable income.
During the period of rapid inflation between
1965 and 1975, consumers stepped up their
rate of personal saving to about 7 percent of
income after taxes.
Consumers have responded much differently to inflation in recent years than in the
past. Since 1977, and especially since late
1979, the saving rate trended
downward,
falling to 3.4 percent by year-end 1979, the
lowest since the early 1950s. Reasons for
this departure
from historical averages are
not clear. It is also unclear whether the sharp
decline in the saving rate is an aberration or
a new norm based upon widespread expectations of continued
high rates of inflation.
The premature
forecasts of a recession in
1979 were based largely on the expectation
that consumers
would step up saving from
income,
simply
because
recent
rates of
personal saving have been low by historical
standards.
Instead,
consumers
cut
back
saving in late 1979, and preliminary
information for early 1980 does not yet suggest a
resumption
of more normal spending-saving
patterns.
Some
of the problems
inherent
in
interpreting
saving behavior are due to the
difficulty
in measuring
personal
saving.
There are two commonly
used concepts of
saving, one that is prepared
by the U.S.
Department
of Commerce
and the other
prepared by the Board of Governors of the
Federal
Reserve
System.
John
Gorman,
assistant
chief
of the National
Income
Division of the U.S. Department
of Commerce, told the Fourth District economists
that both concepts are conceptually
similar

and both have the defect of being derived
from residual computations.f The saving
rate concept
in the national
income and
product accounts is measured as the residual
between disposable
income and total consumer outlays. Income not recorded as being
spent on goods and services, interest payments, and remittances
abroad is assigned
to the saving estimate. The saving concept
in the flow of funds is a net worth concept
that attempts
to measure the changes in
acquisition
of assets less liabilities during a
given period. Here, too, allocation of much
of the assets and liabilities to the household
sector
is based on residual calculations.
Neither concept attempts to measure changes
in the value of assets held by households,
which in recent times have been an important
support for consumer spending. Gorman also
explained that, while there are no conceptual
differences
between the two measures, differences in estimates are sometimes
significant. In the fourth
quarter
of 1979, for
example, the flow of funds concept of saving
showed an increase in personal saving, while
the national income account concept showed
a decrease. Also, the level and rate of personal saving according to the flow of funds
measure are considerably
higher than the
national
income
measure.
Despite
divergences between
these two measures,
both
have shown a declining trend since 1977.
While Gorman viewed this trend as disturbing, he cautioned that the quality of the data
has deteriorated
in recent years. Furthermore, unreported
income may be understating the level and rate of personal saving.
On the product
side of national
income

2.

Although
these two
concepts
are measured
differently,
they may be considered
conceptually
similar because personal saving may include financial assets, such as cash and deposits,
as well as physical assets, such as net acquisition
of real property.

accounts, for example, income can be understated by as much as 'h of 1 percent. Similarly, income can be understated
because of
underreporting.
Nevertheless,
economists
have generally
tended to accept published data that show a
historically
low saving rate as a signal of consumer behavior.
It is uncertain
when or
whether the saving rate will revert to historical
averages. The median forecast of Fourth District round-table
economists
incorporates
a
saving-rate assumption
of about 3.5 percent
in the first half of 1980,4 percent in the third
quarter, and 4.5 percent in the fourth quarter.
Some, however, expect that consumers will
promptly
begin to save more from their
income and spend less in the first half in
response
to heightened
uncertainties
and
growing reluctance
to rely on saving substitutes to maintain
spending.
An economist
commented
that consumers have indeed cut
back on real spending for the past several
quarters, trying simply to maintain their past
standards of living; consumers are unlikely to
commit themselves to purchases of long-term
assets, at least until real income improves.

Defense Spending
Another economic uncertainty
discussed
by the round-table
economists concerns the
rearmament
program. Some economists have
incorporated
higher defense spending into
their outlooks for 1980 and 1981 than that
proposed
by the administration.
Increased
defense spending was expected to moderate
the recession in 1980. Despite the administration's proposed boost in military spending,
the military budget for fiscal year (FY) 1980
and FY 1981-relative
to GNP or to total
federal expenditures-is
virtually unchanqed
from 1970. Congress, therefore,
may accelerate defense spending
by the administration
budget.

beyond that proposed
in the January
1980

Overall, however,
the Fourth
District
economists do not expect much acceleration
in defense spending this year. The median
forecast for defense spending shews a 12.3
percent gain between the fourth quarter of
1979 and the fourth quarter of 1980, hardly
different from the change in the comparable
year-earlier
period. Moreover, it was noted
that both the relatively small magnitudes of
defense spending and the long lags between
the budget proposal and the actual economic
impact
strongly
suggest
that
the 1980

ECONOMIC
COMMENTARY

outlook for economic activity would not be
affected
much
by
accelerated
defense
spending. The lags between contract awards
and deliveries, for example, are as much as
five quarters;
for sophisticated
equipment
the lags are substantially
longer. Lags apparently have lengthened
because of shortages
and bottlenecks.
One defense
contractor
reported that shortages of aluminum forgings
have lengthened
lead times from 34 to 36
weeks to as many as 74 to 76 weeks; lead
times
on micro-processor
circuits
have
averaged
18 to 24 months.
Moreover,
it
would be difficult to expand production
in
the short run because of shortages of skilled
and technical
workers, especially engineers
and scientists;
there is also a shortage of
suppliers for some types of products,
including
forgings,
castings,
and electronic
parts and equipment. The defense contractor
expected
that
supplements
to the
FY
1981
budget
would
boost
real defense
spending for FY 1981 by 4 to 4Y2 percent in
real terms, rather than the 3Y2 percent increase proposed

by the administration.

The views contained herein are not necessarily
those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the
Federal Reserve System.

In this issue:

Reappraising the
Economic .Outlook for 1980
\

Research

Department

Federal Reserve Bank of Cleveland
Post Office Box 6387
Cleveland. Ohio 44101

BULK RATE
U.S~ Postage Paid
Cleveland, OH
Permit No. 385

April 7, 1980

Consumer Behavior
and the Saving Concept
An uncertainty

that

clouds

most

fore-

casts is the marked change in consumer
spending-saving
behavior.
Since the early
1950s, consumers
have saved slightly more
than 6 percent from their disposable income.
During the period of rapid inflation between
1965 and 1975, consumers stepped up their
rate of personal saving to about 7 percent of
income after taxes.
Consumers have responded much differently to inflation in recent years than in the
past. Since 1977, and especially since late
1979, the saving rate trended
downward,
falling to 3.4 percent by year-end 1979, the
lowest since the early 1950s. Reasons for
this departure
from historical averages are
not clear. It is also unclear whether the sharp
decline in the saving rate is an aberration or
a new norm based upon widespread expectations of continued
high rates of inflation.
The premature
forecasts of a recession in
1979 were based largely on the expectation
that consumers
would step up saving from
income,
simply
because
recent
rates of
personal saving have been low by historical
standards.
Instead,
consumers
cut
back
saving in late 1979, and preliminary
information for early 1980 does not yet suggest a
resumption
of more normal spending-saving
patterns.
Some
of the problems
inherent
in
interpreting
saving behavior are due to the
difficulty
in measuring
personal
saving.
There are two commonly
used concepts of
saving, one that is prepared
by the U.S.
Department
of Commerce
and the other
prepared by the Board of Governors of the
Federal
Reserve
System.
John
Gorman,
assistant
chief
of the National
Income
Division of the U.S. Department
of Commerce, told the Fourth District economists
that both concepts are conceptually
similar

and both have the defect of being derived
from residual computations.f The saving
rate concept
in the national
income and
product accounts is measured as the residual
between disposable
income and total consumer outlays. Income not recorded as being
spent on goods and services, interest payments, and remittances
abroad is assigned
to the saving estimate. The saving concept
in the flow of funds is a net worth concept
that attempts
to measure the changes in
acquisition
of assets less liabilities during a
given period. Here, too, allocation of much
of the assets and liabilities to the household
sector
is based on residual calculations.
Neither concept attempts to measure changes
in the value of assets held by households,
which in recent times have been an important
support for consumer spending. Gorman also
explained that, while there are no conceptual
differences
between the two measures, differences in estimates are sometimes
significant. In the fourth
quarter
of 1979, for
example, the flow of funds concept of saving
showed an increase in personal saving, while
the national income account concept showed
a decrease. Also, the level and rate of personal saving according to the flow of funds
measure are considerably
higher than the
national
income
measure.
Despite
divergences between
these two measures,
both
have shown a declining trend since 1977.
While Gorman viewed this trend as disturbing, he cautioned that the quality of the data
has deteriorated
in recent years. Furthermore, unreported
income may be understating the level and rate of personal saving.
On the product
side of national
income

2.

Although
these two
concepts
are measured
differently,
they may be considered
conceptually
similar because personal saving may include financial assets, such as cash and deposits,
as well as physical assets, such as net acquisition
of real property.

accounts, for example, income can be understated by as much as 'h of 1 percent. Similarly, income can be understated
because of
underreporting.
Nevertheless,
economists
have generally
tended to accept published data that show a
historically
low saving rate as a signal of consumer behavior.
It is uncertain
when or
whether the saving rate will revert to historical
averages. The median forecast of Fourth District round-table
economists
incorporates
a
saving-rate assumption
of about 3.5 percent
in the first half of 1980,4 percent in the third
quarter, and 4.5 percent in the fourth quarter.
Some, however, expect that consumers will
promptly
begin to save more from their
income and spend less in the first half in
response
to heightened
uncertainties
and
growing reluctance
to rely on saving substitutes to maintain
spending.
An economist
commented
that consumers have indeed cut
back on real spending for the past several
quarters, trying simply to maintain their past
standards of living; consumers are unlikely to
commit themselves to purchases of long-term
assets, at least until real income improves.

Defense Spending
Another economic uncertainty
discussed
by the round-table
economists concerns the
rearmament
program. Some economists have
incorporated
higher defense spending into
their outlooks for 1980 and 1981 than that
proposed
by the administration.
Increased
defense spending was expected to moderate
the recession in 1980. Despite the administration's proposed boost in military spending,
the military budget for fiscal year (FY) 1980
and FY 1981-relative
to GNP or to total
federal expenditures-is
virtually unchanqed
from 1970. Congress, therefore,
may accelerate defense spending
by the administration
budget.

beyond that proposed
in the January
1980

Overall, however,
the Fourth
District
economists do not expect much acceleration
in defense spending this year. The median
forecast for defense spending shews a 12.3
percent gain between the fourth quarter of
1979 and the fourth quarter of 1980, hardly
different from the change in the comparable
year-earlier
period. Moreover, it was noted
that both the relatively small magnitudes of
defense spending and the long lags between
the budget proposal and the actual economic
impact
strongly
suggest
that
the 1980

ECONOMIC
COMMENTARY

outlook for economic activity would not be
affected
much
by
accelerated
defense
spending. The lags between contract awards
and deliveries, for example, are as much as
five quarters;
for sophisticated
equipment
the lags are substantially
longer. Lags apparently have lengthened
because of shortages
and bottlenecks.
One defense
contractor
reported that shortages of aluminum forgings
have lengthened
lead times from 34 to 36
weeks to as many as 74 to 76 weeks; lead
times
on micro-processor
circuits
have
averaged
18 to 24 months.
Moreover,
it
would be difficult to expand production
in
the short run because of shortages of skilled
and technical
workers, especially engineers
and scientists;
there is also a shortage of
suppliers for some types of products,
including
forgings,
castings,
and electronic
parts and equipment. The defense contractor
expected
that
supplements
to the
FY
1981
budget
would
boost
real defense
spending for FY 1981 by 4 to 4Y2 percent in
real terms, rather than the 3Y2 percent increase proposed

by the administration.

The views contained herein are not necessarily
those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the
Federal Reserve System.

In this issue:

Reappraising the
Economic .Outlook for 1980
\

Research

Department

Federal Reserve Bank of Cleveland
Post Office Box 6387
Cleveland. Ohio 44101

BULK RATE
U.S~ Postage Paid
Cleveland, OH
Permit No. 385

Reappraising the Economic Outlook for 1980
Twenty-eight economists met at the Federal Reserve Bank of Cleveland early in March to
discuss the economy. This Economic Commentary
reviews the appraisal of the economic
outlook that emerged from that meeting.
A rapid chain of events since late January has
added uncertainties
to an already uncertain
economic
outlook
for 1980. Among these
developments
are the stronger than expected
pace of economic activity at the beginning
of the year, the acceleration
in consumer
and producer prices, and the administration's
proposed
budget
that originally
showed
sizable deficits for fiscal years 1980 and
1981. The perception
in domestic financial
markets that fiscal policies are incompatible
with an anti-inflation
objective has crippled
equity and bond markets,
and has helped
boost short-term
interest rates 200 to 400
basis points
between
mid-February
and
mid-March. The effects of the rapid run up
in interest rates on spending decisions are
unknown, as are the effects of the latest set
of anti-inflation
measures announced
in midMarch.

Fourth District Economists
Round Table Forecasts
Against

this

background

of rapid

eco-

nomic changes,
forecasters
have adjusted
their economic
and financial outlooks
for
1980, and further
adjustments
now seem
likely.
The
Fourth
District
Economists
Round Table
appraise
the
developments

met on March 7, 1980, to
economic
outlook,
while
described
above were still

unfolding.
Although the round-table
economists
revised upward
their outlook
for
inflation
and output
in 1980 from their
forecasts at a similar meeting last November,
they held to their earlier view that a recession
would be under way in early 1980.

The round-table
forecast
of recession
last November was dominated
by a view of
weakening
consumption
expenditures,
led
by an upward shift in consumer saving from
a 30-year low in the fourth quarter of 1979.
At that meeting the recession was expected
to begin in the final quarter of 1979 and to
extend
into the third quarter
of 1980.
Measured
between
peak
and trough,
a
contraction
of 2.2 percent was foreseen in
real GNP, somewhat
less than the average
decline of six recessions in the post-World
War II period.
Economists
at the March 1980 round
table still expected a recession in 1980, but
one that would be milder than anticipated
last November.
decline about
trough,

the

Real GNP is now expected to
1 percent between peak and
same

as the

relatively

mild

recessions in 1960-1961
and 1969- 1970.1
All but a few of the round-table economists
expected
a recession to last about three
quarters. The issues that divided the economists concerned the timing and depth of the
recession. Of the 28 economists who attended
the round table, 15 forecast a slight decline
in real GNP in the first quarter of 1980;
most of the remaining economists forecast a
recession that would get under way in the
second
quarter.
The median
round-table
forecast
showed
annual
rates of decline
in real GNP of 0.2 percent in the first quarter,

in the fi rst quarter

Table 1

of 1981.

be as weak as expected last November.
Nowhere is the recession more evident
than in residential construction,
which has
been weakening
in recent months. Housing

Expectations

Median Forecasts of Changes in GNP and Related lterns"

1979

Actual

1980

Forecast

1979

Iva

la

lIa

1980

lila

Change in levels, billions of dollars,
Gross national

(GNP)

Gross private domestic
investment
Nonresidential
fixed
investment
Residential construction
Changes in business
inventories
Net exports
Government

1981
la

saar

purchases

241.8

215.9

62.9

56.1

34.4

44.0

64.7

77.0

159.2

169.9

52.6

45.8

30.0

39.3

39.7

41.0

35.7

-2.1

-4.8

-1.7

-1.2

-4.3

4.1

15.6

33.5
6.2

19.1
-10.8

5.8
-6.7

3.0
-6.4

3.5

0.6

-4.0

1.7

3.1
7.4

-3.8

-14.7

-7.8

-1.3

-0.5

-3.7

0.2

4.9

-3.8

-8.2

12.5

-0.5

1.2

0.0

-0.7

40.8

54.9

23.4

10.4

12.5

12.2

15.4

12.6

10.4

12.1
9.3
2.5
6.4

2.4

Percent
GNP, current dollars
Implicit price deflator
GNP, constant dollars
Industrial

Iva

6.1

product

Personal consumption
expenditures

production

11.4

9.1

changes,
9.4

rate, percent

1.0

annual

rates

7.1
8.8

2.3

9.1
-0.2

10.9
8.6
2.1

10.0
-0.2

5.6
9.2
-2.8

-1.6

8.8
0.5

4.1

-1.8

-0.3

-0.5

-5.8

-5.2

0.7

8.8

Absolute
Unemployment

1. Since the March 7 meeting, several of the economists have revised downward their forecasts
of real GNP to show a decline of about 2.5 to
3.0 percent between the fourth quarter of 1979
and the third quarter of 1980.

of a milder recession stemmed largely from
a belief that consumer
spending would not

2.8 percent in the second, and 1.6 percent in
the third (see table 1). The beginning of an
upturn in business activity was foreseen in the
final quarter of the year, followed by a 2.5
percent annual rate of expansion in real GNP

6.0

6.9

5.9

6.3

levels
6.8

7.2

7.5

7.4

a. Median forecasts are based on individual forecasts of the Fourth District Economists Round Table;
they do not represent forecasts of the Federal ReserveBank of Cleveland or of the Board of Governors
of the Federal ReserveSystem.
SOURCE:

Fourth District Economists Round Table, Federal ReserveBank of Cleveland, March 7, 1980.

starts have been declining since early 1978.
From March 1979 until September
1979,
new housing starts ranged between an annual
rate of 1.8 to 1.9 million units. In February
1980, housing starts fell to an annual rate of
1.3 mi Ilion units; housing starts plummeted
further in March to an annual rate of 1.0
million units. Sales of new and used houses
have slumped,
leading to a softening
in
home-purchase
prices. One of the Fourth
District economists
suggested that housing
starts would continue
to decline during the
balance of 1980. Several reasons were given
to support this view. The sharp run up in
interest rates affects both mortgage lenders
and buyers. Thrift institutions
could find it
increasingly
difficult
to attract
and hold
deposits, especially since the ceiling rate of
12 percent was established
for the 2Y2-year
money-market
certificate effective March 1,
1980.
There
is some doubt,
moreover,
about the willingness of some thrift institutions to issue six-month savings certificates
because of severely squeezed profit margins.
Demand for mortgage
loans at 13 percent
was sa id to be soft, and at 15 to 17 percent
demand would weaken even more. Moreover,
investment psychology in relation to housing
appears to have weakened.
In recent years
investors
perceived
rates of return
from
housing in a range of 20 to 30 percent, but
softness in house prices and the inability to
sell homes have reduced the expected return.
In addition,
yields on competing
financial
instruments were 15 percent or more.
Fourth District economists expect newcar sales to
forecast of
sales at 9.7
10.6 million

decline again in 1980. The median
seven economists
shows new-car
million units, compared with the
sales in 1979. Sales of small cars,

both domestic
and imports, are again expected to account for a larger share of total
cars at the expense of large and intermediatesized cars.

Although
over one-half of the roundtable economists
expected the recession to
begin in the first quarter,
others doubted
that a recession would occur before the
second or third quarter of 1980. One of the
economists
pointed out that a shift away
from a recession psychology has temporarily
spurred
economic
activity,
perhaps
best
illustrated
by a turnabout
in inventory
policies. Some industries that were depleting
inventory
in late 1979 are no longer doing
so; indeed,
they
may even be building
stocks because of a shift in psychology.
At
the center of this shift is the steel industry,
for which orders picked up early in 1980 but
have since fallen. Steel economists, therefore,
have upgraded
thei r forecasts
for steel
shipments
for the first half of 1980-a
development,
however, that might contribute
to somewhat
greater
weakness
in
production
during the second half.
Skepticism over a mild recession scenario
was expressed
by some
believed that high inflation

economists
and interest

who
rates

would result in a more serious recession than
indicated
in the median forecast.
Expectations of a deeper recession, with a peak to
trough decl ine of perhaps 2.5 percent, were
based on a perception that economic policies
would tighten in order to control inflation.
The resulting
higher interest
rates would
further
weaken
interest-sensitive
markets,
such
as residential
construction.
Some
economists
acknowledged
that
the high
interest
rates and inflation of early 1980
have no parallel in previous experience and
that their implications
for economic activity
are uncertain.
The more severe recession
scenario also assumes an upward shift in the
rate of personal
saving toward
historical
relationships.
Therefore,
curtailment
in
consumer spending, as well as in residential
construction,
was seen as having cumulative
downward

effects elsewhere

in the economy.