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August 15, 1 980

Consumersand the Recession
As recent headlines told us, the U.S. economy fell deeply into recession during the second quarter, with a 9.1-percent annual rate of
decline in real GNP. That decline was the
sharpest one of the past generation, except for
the equally sharp decline of first-quarter
1 975. Who was responsible for this performance? Appropriately, it was the consumer-who was also largely responsible for the
strong and prolonged expansion of the late
1970's.
The current recession may turn out to be
unusual, because ofthe possibility that the
downturn will be concentrated in its initial
quarter. (In fact, the Congressional Budget
Office esti mates that that quarter wi II accou nt
for two-thirds of the recession's cumulative
downturn.) In contrast, in four of six previous
recessions, the most severe quarterly decline
occurred in the final quarter. However, this
recession is not yet over, and its final shape
wi II depend greatly on what the consumer
does from now on.

1975 vs.1980
The shift in the consumer's role can be seen
from a comparison of the contributors to the
real-GN P declines offirst-quarter 1975 and
second-quarter 1 980 (seechart}. In the earlier
period, the inventory sector dominated the
decline. Inventories had gotten far out of line
in a period of weakening demand, because
business firms-responding to sharp price
increases of raw materials-boosted their
purchases of supplies in anticipation of
further price increases. As a consequence,
these firms were forced to reduce their inventories severely in the early part of 1975.
But for most other GN P components, the recession already was almost over. Consumption spending had already turned positive,
and residential consumption had almost
bottomed out-although business capital
spending still had several quarters of decline
ahead.
In second-quarter 1 980, in contrast, con-

sumer spending accounted for two-thirds of
the entire decline in total output-whereas
inventory spending actually increased somewhat as an unwanted consequence of the
drop in consumer spending. The drop in
consumer purchases was concentrated in
durable goods-especially autos, which registered their lowest selling rate in more than
two decades. But the household spending
decline was also reflected in a one-fifth reduction of residential construction spending
from the previous quarter.
The economy actually had been declining
since January, according to the chronology of
the semi-official National Bureau of Economic Research. Employment, retail sales,
and industrial production all began to decline
during the winter quarter, reflecting the distortions caused by the upsurge of energy and
other prices.

Sourcesof weakness
The second quarter was notable, however, for
marking the culmination of an unprecedented rise in interest rates, whose effects
were keenly felt throughout the household
sector. Housing probably suffered most as
mortgage rates soared to the range of 16 to 1 8
percent, at which point home construction
and sales skidded to a halt. Auto sales also
reflected the high cost of credit, both for
household purchases and dealers' flooring
loans, which were linked to a prime businessloan rate which peaked at 20 percent during
this period.
Consumer spending also reacted to the severe inflation, seen most obviously in the
11O-percent increase in OPEC oil prices in
1979 and early 1 980. The impact spread well
beyond autos and gasoline. As fuel costs
climbed, transportation fares rose accordingly.ln response, non-commercial travel
dropped by 10 to 20 percent, and hotel-motel
and related leisure services suffered in simi lar .
fashion.

Opinions

e)cpreSsed in this newsletter do not

necessariiy reflect the views of the l'Tlanagement
of the Federa! Reserve Bank of San Francisco,

nor of the Board of CovenH.1rs of the Federal
Reserve System.
savings rate during the second quarter-:savings, the residual, automatically increased
as debt-supported spending declined.
Whether willingly or not, consumers began
to repair their balance sheets by reducing
their new-debt assumption, thereby raising
their savings rate. But the one-percent rise in
the savings rate had the effect of reducing
consumption spending by $1 7 billion below
what it otherwise would have been.

But in many respects, the consumer caution
of mid-1 980 was a response to an earlier
spending pace which continually outpaced
income. During 1 979, for example, real consumption increased only 1.6 percent, but that
was three times that year's increase in real
income. (Most of the consumption increase
occurred in the second half, when income
gains were very weald Consumers financed
this spending/income gap partly by increasing external financing, raising the ratio of
instalment credit extensions to a record 20.3
percent of after-tax income. Consumers also
sharply reduced their rate of saving out of
after-tax income, bringing it down from 5.4
percent to 3.5 percent in the second half of
the year.

Repeatpast trends?
Atthis point, no one can foretell what role the
conSumer will play in creating and sustaining
an eventual business upturn. Over the past
quarter-centufy, the first year of cyclical recovery typically has been marked by a jump
of 6.6 percent in real GN P. In that first robust
year, consumers generally regain their lost
confidence and begin buying again-and
business firms respond by increasing their
orders to fill out their depleted inventories,
thus setting the stage for further increases in
production and employment.

Consumers sharply increased their borrowing in 1979, either through instalment-debt
extensions or through inflation-enhanced
equity in homes. Consumer credit outstanding increased almost 15 percent over the previous year's level. Meanwhile, home-equity
loans ran as high as an estimated $1 00 billion
in 1979, or more than 6 percent of after-tax
income.

Most forecasters today, although assuming a
tu rnarou nd by the end of the year or thereabouts, do not envision a full-scale recovery
in 1 981 . The Congressional Budget Office
recently projected real GN P growth within
the range of 2 Y2to 4 V2percent between the
fourth quarter of 1 980 and the fourth quarter
of 1981 , and the Office'of Management and
Budget came in with a forecast near the lower
end of that range. But whatever happens, the
consumer will playa crucial role in determining the strength of the upturn.

Debt and savings
All that changed by the second quarter of
1 980, however, as consumers sharply reduced their new debt-to-income ratio to 1 4.6
percent -almost six percentage points below
the year-ago figure. They were encouraged to
cut back by the Federal Reserve's creditrestraint program, which was imposed in
mid-March to dampen the speculative buying that had affected many financial markets
in the early part of the year. The program did
not apply to the already weakened auto and
housing markets, but it affected credit-card
and similar purchases as lenders took this
opportunity to tighten credit terms much
more than they had previously been willing
to do. Before being removed in early July, the
controls -along with the recession -helped
bring aboutan almost unprecedented secondquarter decline of $9.0 billion in outstanding
credit.

A few optimistic signs have already surfaced.
Home-building activity increased sharply in
June, although still lagging 37 percent behind
the year-ago figure. Retail sales rose for the
second straight month in July, with autos
leading the advance, although auto sales totals were still the worst for any July of the last
1 8 years. But a great deal still depends on the
near-term state of consumer income, consumer borrowing intentions, and above all,
consumer psychology.

Herbert Runyon

In a parallel move, consumers increased their
2

SH ARES OF REAL GN P DECLINE
Billions of
1980 dollars

o

Total GNP
Consumer
spending
Residential
construction
Business
spending

capital

Inventory
investment

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BANKING DATA-TWELFTHFEDERAL
RESERVE
DISTRICT
(Dollaramountsin millions)
Selected
Assets Liabilities
and
Large
CommercialBanks
Loans
(gross,
adjusted) investments*
and
Loans
(gross,
adjusted) total#
Commercial industrial
and
Realestate
Loans individuals
to
Securities
loans
U.s. Treasury
securities*
Othersecurities*
Demanddeposits total#
Demand
deposits adjusted
Savings
deposits total
Timedeposits total#
Individuals,
part.& corp.
(Large
negotiable
CD's)
WeeklyAverages
of Daily Figures
MemberBankReserve
Position
Excess
Reserves )/Deficiency
(+
(-)
Borrowings
Net freereserves+ )/Netborrowed{
(
-)

Amount
Outstanding
7/30/80
136,973
115,253
33,240
46,890
23,591
869
6,299
15,421
42,797
31,119
28,925
61,642
53,417
22,405

Change
from
yearago
Dollar
Percent

Change
from
7/23/80
-

-

-

42
8
4
87
43
116
9
41
597
92
55
103
46
120

-

-

Weekended

Weekended

7/30/80

7/23/80

92
4
96

50
30
80

6,750
7,656
1,423
7,602
973
1,018
1,128
222
1,061
175
1,641
10,513
10,769
4,381

-

5.2
7.1
4.5
19.3
4.3
53.9
15.2
1.5
2.4
0.6
5.4
20.6
25.3
24.3

Comparable
year-ago
period
18
75
58

* Excludes
tradingaccountsecurities.
# Includesitemsnot shownseparately.
Editorialcomments
maybeaddressed theeditor (William Burke)or to the author.... Free
to
copies this
of
andother Federal
Reserve
publications be obtained callingor writing thePublicInformation
can
by
Section,
Federal
Reserve
Bank-of Francisco,
San
P.O.Box7702,SanFrancisco
94120.Phone
(415)544-2184.