What Depressed the Consumer? The Household Balance Sheet and the 1973-75 Recession.

This article focuses on the balance-sheet position of U.S. households during the 1973-1975 economic recession in the U.S. Because other developments in the economy influence it, the balance sheet of U.S. households must be viewed as endogenous. In the absence of money illusion, the consumer would be concerned with his balance-sheet position in terms of the goods and services he could but, and thus balance-sheet items that are deflated to real terms should be most relevant to consumer spending decisions. Two basic approaches to consumer behavior postulate that changes in the household balance sheet affect consumer spending decisions. The life-cycle hypothesis of saving concentrates on the consumer's consumption decisions with regard to nondurable goods and services, while the liquidity hypothesis centers on the consumer's decision to acquire tangible assets such as consumer durables or housing. A problem arises because the use of a distributed lag on household holdings of stock-market assets--a practice without strong theoretical justification--may be responsible for the appearance of balance-sheet effects. Toward the end of the recession, balance-sheet effects operated more through net-wealth, life-cycle channels.