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April 25, 1 980
Forecasting
Recessions
The long-awaited recession has finally
arrived, it would appear, judging from the
recent weakness of production and retail
sales, as well as the obvious problems of-key
industries such as autos and housing. "The
economy peaked in January and then began
a slide into recession," the Commerce
Department's chief economist Courtenay
Slater said last week. Although she and others
won't make it official until they see two
consecutive quarters of declining real
growth, the evidence they cite is somewhat
stronger than during the preceding year
or more of false alarms.
In late 1 978, most forecasters expected
a slow year in 1979, with either a "soft
landing" or (more likely) an actual downturn
in business activity. In those circumstances,
they also expected the inflation rate to
decelerate from the 7.3-percent increase
recorded for 1978. As it turned out, real G N P
rose 2.3 percent between 1 978 and 1979,
with on Iy the second quarter of the year
showing significant weakness. And inflation,
rather than receding, accelerated during the
year. Consequently, it may be usefuI to
examine the unexpected strengths which
developed in various sectors of the 1979
economy, and to compare them with the
apparent weaknesses in the same sectors
this year.
A mild recession seemed to be a logical
forecast to make a year ago. The typical
scenario included a substantial slowdown in
employment, which had been increasingata
record peacetime rate since the early 1975
trough. Consumers seemed likely to reduce
their spending, as a result of their heavy debt
burdens and the inflation-caused erosion of
their real after-tax incomes. With consumer
spending dropping, businesses seemed likely
to be forced into liquidating the inventories
which they had involuntarily accumulated
during the spending downturn. And with
interest rates climbing, the funds-short
housing industry seemed set for a substantial
decline. All ofthese signs spelled outa classic
script for at least a mild recession.
How '79 turned out
Interestingly enough, all of these signs
actually appeared -at least to some extentduring 1 979. Still, the economy forged
ahead, with only one quarter of actual
decline-and that resulted from an external
shock, the cutoff of Iranian oil. Indeed, the
cutback in two related expenditure items
(autos and parts, and gasoline and Oil)
accounted for the entire second-quarter
decline in consumption spending, which in
turn accounted for four-fifths of the quarterly
decline in real GNP.
Inventories behaved generally as expected in
1 979, increasing almost by half during the
second-quarter consumer-spending
downturn, and increasing at a much slower
pace during the remainder of the year.
Business firms boosted their stocks at an .
$1 8.1 -billion rate in the second quarter, but
at only a $l.4-billion rate in the final quarter
of the year. So although there was no actual
I iqu idation, what had appeared to be a glut of
inventories was reduced in orderly fashion by
year-end. Many observers consequently saw
little danger of inventories becoming a
contractive force in 1 980.
The home-construction sector also behaved
somewhat as expected, with housing starts
declining 24 percent in response to rapidly
rising housing prices and tighter mortgagecredit conditions. Even so, real expenditures
for housing dropped on Iy 7 percent, partly
because physical production lagged
considerably behind the decline in starts, and
partly because spending on alterations and
remodeling remained high during the year.
Meanwhile, business capital spending
behaved somewhat better than anticipated.
As a highly cyclical sector, it would be
expected to decline in the weak business
Opinions
r!ece(;s,lrilv
in this
rHieel
do not
[1,(" vic,:vl/s Oi the
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inflationary future. But surprisingly, durablegoods spending weakened in real terms duri ng the year, and most of the strength
(especially in the second half) occurred in the
areas of services and nondurable goods, such
as clothing. Still, the "buy now" psychology
was an important spending stimulus in most
consumer markets during the year.
climate expected in 1 979. Instead, capital
spending outpaced the growth of the overall
economy, despite some weakness toward the
end of the year.
Sltrengthin consumerspending
Nonetheless, consumer
represented
the most evident (and most unexpected)
source of strength in the 1 979 economy. Real
consumer spending increased by 1.6 percent
between the fourth quarter of 1 978 and the
fourth quarter of 1 979, while real G N P
increased by only 0.6 percent over that
period. (Incidentally, all ofthe growth in
household expenditures
concentrated in
the second half of 1 979, thereby accounting
for the strength ofthe overall economy during
that period.) But real after-tax income
increased by only 0.2 percent over the year,
so that consumers were able to expand their
purchases only by cutting into savings and
expanding their borrowings.
The consumer response to inflation in 1 979
contrasted sharply with the response in
similaryearof accelerating inflation
atthe end of a prolonged business expansion.
In that earlier period, consumers reacted to
rising prices by reducing spending and increasing savings, instead of doing the reverse as in
1979. This difference in response apparently
reflected differing perceptjons ofthe nature of
the inflation faced by consumers. In 1 973,
consumers had two years of comparatively
low and stable prices behind them, thanks to
a program of wage and price controls, and
hence they responded cautiously to the
uncertainty imposed by an unanticipated rise
in the inflation rate. Although real consumption spending increased at about the same
pace in 1973 as in 1 979i1 .7 percent), the
increase in real disposable income was much
greater in that earlier year (4.1 versus
0.2 percent). Thus in 1973, as compared with
1979, consumers responded to inflation by
boosting their savings and reducing their
burden of debt.
Consumers drastically reduced their saving
rate, from a 1 978-79 average of 5.0 percent
(of disposable income) to a low of only
3.5 percent in the final quarter of 1979. Atthe
same time, they boosted their debt, either by
increasing their instalment credit or by
borrowing against the inflation-enhanced
equity in their homes. Estimates of borrowing
against home equity ranged from $50 billion
to $1 00 bi II ion, equal to about 3 to 6 percent
of disposable income. Whatever the exact
figure, considerable amounts not arising from
current income went into consumer
purchases during 1 979, thus giving an extra
boost to total spending during the year.
Forecasting 980
1
On the basis of recent evidence, forecasters
predicting a recession in early 1 980 will be
closer to the truth than those who predicted a
recession a year ago. The basic source of
weakness apparently is the consumer-the
source of most of the strength in the 1 979
economy. In the first quarter of 1 980, real
consumer spending for goods actually
declined, and only spending for services
increased. Atthe same time, real spending for
residential construction dropped substantially, reflecting last year's decline in housing
starts. The sharp tightening of credit, along
with stagnant real incomes and a very low
level of household savings, has made it
The unexpected strength of consumer spending undoubtedly reflectedthe state of consumer psychology, which increasingly
became dominated by the high and accelerating rate of inflation. Understandably,
consumers spent more in anticipation of
higher prices in the future. In such a frame of
mind, consumers could be expected to boost
spending for durable goods, since buying
such long-I ived items at 1 979 prices shou Id
. ensure considerable relative savings over an
2
_--_._.-
..
stable. Federal government spending meanwhile continued to strengthen, as it did in the
latter part of 1979. But to repeat, the consumer seems to be the main reason why
recession forecasters went wrong in 1979
and why they appear to be correct in 1980.
Herbert Runyon
impossible for consumers to continue with
their "buy now" spending behavior of 1979.
Other G N P sectors generally moved sideways in first-quarter 1980, in real terms.
Business capital-goods spending increased
modestly, and business inventories remained
Percent
20
Debt/Income
Ratio**
......._., . . A' ...-'_. _'-'- . - ....--.--../.-.
-. .
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Inflation
10
X-x_x_x,
/
x
Savings
1973
Rate
"-
*
Rate
5
o
......... _. _. _. -.
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1975
1977
3
1979
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BANKINGDATA-TWELFTH
FEDERAL
RESERVE
DISTRICT
(Dollaramounts millions)
in
Selected
Assets Liabilities
and
largeCommercial
Banks
Loans·
(gross,
adjusted) investments*
and
Loans
(gross,
adjusted) total#
Commercial industrial
and
Real
estate
Loans individuals
to
Securities
loans
U.s.Treasury
securities*
Othersecurities*
Demand
deposits total#
Demand
deposits adjusted
Savings
deposits total
Timedeposits total#
Individuals, & corp.
part.
(Large
negotiable
CD's)
Weekly
Averages
of Daily Figures
MemberBankReserve
Position
Excess
Reserves )/Deficiency
(+
(-)
Borrowings
Netfreereserves )/Netborrowed( )
(+
-
• l?pl?AaN • Oljl?PI
I?UOZ!J'v' "
I?>jSl?IV
Amount
Outstanding
4/9/80
139,487
117,689
33,890
45,732
24,394
1,007
6,525
15,273
45,147
33,230
27,059
62,951
54,432
22,462
Weekended
4/9/80
-
21
200
179
Change
from
yearago
Dollar
Percent
Change
from
4/2/80
345
278
- 142
+ 189
93
- 216
+ 18
+ 49
-1,683
+ 956
- 165
+ 924
+ 849
+ 560
+
+
+
+
+
+
+
15,232
16,251
3,627
9,144
3,058
485
1,498
479
+
+ 1,315
+ 1,181
3,182
+ 12,976
+ 13,767
+ 4,900
Weekended
4/2/80
107
42
66
+
+
+
+
+
12.3
16.0
12.0
25.0
14.3
- 32.5
- 18.7
+ 3.2
+ 3.0
+ 3.7
- 10.5
+ 26.0
+ 33.9
+ 27.9
Comparable
year-ago
periOd
48
11
37
* Excludes
tradingaccount
securities.
# Includes
itemsnotshownseparately.
Editorial
comments be addressed theeditor(WilliamBurlee) to theauthor••.• Free
may.
to
or
copies this
of
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Reserve
publications beobtained calling writingthePublicInfonnation
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or
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Reserve
Bank SanFrancisco, Box7702, San
of
P.O.
Francisco4120,Phone
9
(415)544-2184.
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