Savings by American households have soared to $1.1 trillion above their long-term average from 1965 to 2020. That excess savings and near-term policy decisions around fiscal aid and stimulus will play a large role in determining the shape, scale and duration of what we expect to be the coming economic expansion.
Savings by American households have soared to $1.1 trillion above their long-term average.
On the surface, our forecast of 5.4% growth in U.S. gross domestic product this year appears somewhat optimistic given the current pandemic-induced challenges. But it is predicated on the notion that not all of that savings will be spent in a near-term release of pent-up demand.
Rather, we anticipate that U.S. households, because of the shock of the pandemic, will engage in years of precautionary savings that will result in an elongated release of pent-up demand.
Based on our research and forecast, we anticipate that it could take anywhere from two to four years for the savings rate to return to trend, which will create the conditions for fairly strong growth over the next few years.
This, however, does not obviate the need for immediate fiscal aid that targets those out of work and those who will face structural unemployment following the recession. Targeted and smart government support will be necessary in the near to medium term to return to full employment.
Second, the excess savings compared to the pre-pandemic level contributes to a growing body of work that implies excess savings around the world directly contributes to lower interest rates and lower inflation. In our estimation, there is a systemic surplus of financial capital relative to demand for capital investment. This is why interest rates and inflation have trended lower over the past four decades, well before the era of large-scale asset purchases by central banks, and will continue to remain low by historical standards.
Moreover, in a digital economy that drives the marginal costs of replication, access and distribution of services to zero, which results in a surplus of services and consumer goods, the likelihood of a near-term increase in inflation or interest rates remains quite low.
This implies that there is plenty of fiscal space for the U.S. to address immediate needs along with long-term neglected social needs and the modernization of the economy through infrastructure spending.
Precautionary savings and the U.S. economy
The enormity of uncertainty surrounding the coronavirus — and its effect on the economy in 2020 — can be observed in the unprecedented rise in personal savings at the expense of normal levels of consumer spending.
Consider that at the depth of the economic shutdown last April, the level of personal savings rose to an unprecedented $6.4 trillion. That was more than five times higher than its pre-pandemic average of about $1.1 trillion. By December, the level of savings had eased to $2.4 trillion, more than twice its five-year average.
As we’ll discuss later, the $1.1 trillion increase in savings over its pre-pandemic average represents money not spent by consumers. The government’s success in containing the pandemic this year will determine the direction of household savings and spending in the coming months.
That will play a major role in determining the amount of government effort required and the duration of those efforts necessary for restoring income and employment levels to pre-pandemic levels.
We can categorize personal savings as either “life-cycle savings” or “precautionary savings.” Life-cycle savings are typically lower for households as they start out, as young families spend most of their available income on big-ticket items from housing and cars to child-rearing and education. As households grow older, life-cycle savings increase as family expenses decline and financial concerns become centered on funding for retirement.
We define “precautionary savings” as resulting from belt-tightening during episodes of uncertainty. This deferred spending can result from job insecurity, medical insecurity, or financial or economic shocks that threaten the health of household balance sheets. Clearly, the increase in personal saving since last March is an abnormal jump in precautionary savings as families struggle to live within suddenly restricted means.
While the gradual increase in the nominal level of savings over time shown in the figure above is affected by the inflation of incomes, we can see the impact of the business cycle on household savings by looking at the year-over-year growth rate of personal savings in the figure below.
As expected, the year-over-year growth rate of life-cycle savings mean reverts to around zero from year to year as new households replace older households. During episodes of economic and financial stress, however, we would expect households to tighten their belts, lower discretionary spending and increase precautionary savings.
While the growth rate of precautionary savings typically increases during recessions, it then dissipates as employment uncertainty gives way to income security. Personal savings grew at a yearly rate of more than 100% during the near-depression period of the 2008-09 Great Recession.
During 2020, the yearly growth rate of savings reached 400% before receding to 99% higher by December. With the labor market still in distress, the level of precautionary savings remains a concern for the economy.
Finally, we can further normalize savings over the course of time by looking at personal savings as a percent of household disposable income shown in the figure below.
The postwar history of savings evolves from the immediate recovery in the 1950s that included the pent-up demand of the Depression-era generation and recovery, and the development of the consumer-driven economy.
At the depths of the economic shutdown in April , savings reached nearly 34% of disposable income.
Savings in the 1960s stabilized and increased until 1975, along with the maturity of wartime adults. After 1975, savings declined as baby boomers came of age and credit cards made spending easy and fun. By 2005, pensions were a thing of the past, and individual savings became a prerequisite for a population hoping to retire one day.
Baby boomers’ parents and grandparents had a good point in regard to the 35-year decline in savings from 15% of disposable income in the 1970s to 2% by 2005. The spending of the baby boomers became shortsighted and irresponsible, and it took a housing market fiasco and the financial meltdown to put an end to it.
Baby boomers had to quickly reconsider the risks in their household balance sheets, and an upward trend in savings emerged in the Great Recession and into the 2010s before plateauing during the decadelong recovery.
To put the pandemic panic savings in perspective, we need a baseline. We’ve chosen the period from 1995 until 2020, which includes periods of decreasing and increasing trends of personal savings.
The average rate of savings during nonrecession months between 1995 and 2020 was 6.2% of disposable income. At the depths of the economic shutdown in April 2020, savings reached nearly 34% of disposable income. That has since receded to 13.7% in December 2020, which is still twice as high as the baseline average.
The last time savings was this high was from 1973 to 1975, when the supply shock of oil embargoes brought on the period of soaring inflation and low growth that gripped the nation’s psyche.
Forecasting the duration of the excess savings
Can we forecast the length of time for the savings ratio to return to trend after the surreal events of the past 12 months? We can try, but with the caveat that events are likely to dictate the length of time before the coronavirus is no longer a factor in determining economic activity, or in the household decision-making process.
It could take anywhere from two to four years for the savings rate to return to trend.
Using data collected during modern-era business cycles — and considering the shift from the general decline in savings from 1975 to 2005, to the increase in savings from 2005 to 2020 — we can surmise that it could take anywhere from two to four years for the savings rate to return to trend.
Though 44 months is the average duration of above-normal levels of savings, that should be seen in the context of the range of characteristics among the six recent recession periods.
The 1973-75 recession was caused by a supply shock (crude oil). The early-1990s recession was the aftermath of fiscal policy decisions ending the defense spending spree of the Reagan-Bush years. The 2001 and 2008-09 recessions were the results of financial excesses and collapse.
This current recession is the result of policy decisions that disrupted global trade and sent global manufacturing into a tailspin. The business-cycle downturn was then punctuated by the horrific — and then horrifically mismanaged — health crisis, which created a supply shock that morphed into a demand shock and widespread unemployment.
Somewhat ironically as the world moves away from fossil fuels, the current recession’s closest relative might turn out to be the so-called double-dip recession of the 1980s that was a worldwide collapse after a series of energy shocks. It took 47 months for savings to return to trend after that episode.
Consider that the disruption of the last 10 months is unlikely to be temporary or easily overcome. Lasting changes in how we work and shop will affect the employment of millions of service workers who now become the responsibility of the public sector.
Yes, we expect a surge of spending once the public is vaccinated — similar to the pent-up demand and declining savings of the post-Depression and postwar period of the 1950s. But there will also be physical considerations that cannot be corrected by a vaccine and psychological factors that will likely extend beyond the duration of the recession.
Let’s start with the physical factors that will have more to do with the income side of the equation rather than the saving side. Consider that many of us have not had a professional haircut in 10 months, have avoided the dentist or foregone elective surgeries and have not had dinner inside a restaurant in almost a year. Even if the vaccines were to be quickly distributed, we cannot make up for the lost economic output of 10 foregone monthly visits to the barbershop.
Neither will restaurant owners or their landlords who will have lost a year of revenue. And let’s not forget the lost tips for the people who serve our drinks and meals or the store clerks where we used to shop. Unless there is significant government support for the service sector, a substantial segment of the economy that relies on personal consumption will remain scarred by the pandemic and will continue to put aside whatever income they might accrue.
Yet it’s not just the proprietors and wait-staff carrying the scars, and this is where the psychological effects of an economic crisis come in.
Just as Depression-era generations balanced their propensity to spend by their need to save just in case the impossible disaster becomes possible, the surge in savings in 2020 suggests that not only were households forced by the pandemic to live within their means, but they also have taken it upon themselves to increase savings at the expense of spending.
There is good reason for folks to remain cautious. Despite medical advances, the world has indeed become smaller and there have been global outbreaks of disease in each of the past three decades. And even with ostensible advances in monetary and fiscal policy, we have not been able to protect the business cycle from events or policy mistakes. We have gone through a recession every 10 years.
If it takes two to four years for a resumption of normal levels of savings, as history might suggest, then policies should be constructed around restoring confidence in the monetary and fiscal authorities’ commitment to acting swiftly.
In the current episode, there needs to be commitments (among others) to:
1. Provide jobs and temporary income support for the millions of unemployed.
2. Provide support in the commercial real estate sector and others affected by pandemic closings.
3. Provide training for service workers so they can change fields (health care is the obvious need).
4. Construct adequate health care facilities in underserved areas.
5. Fund construction of schools that can better meet social distancing requirements of the next outbreak of disease.
6. Fund the advancement of the digital world to all points of the country.
7. Promote advanced manufacturing through education of the labor force and provide grants for the development of new technologies.
8. Develop programs to help those sectors singled out by the need to contain the virus, with the performing arts particularly in mind.
As we’ve stressed before, a fiscal stimulus that is too small to be effective or too slow to prevent the degradation of the labor force might not be cost effective. With nominal interest rates at near-zero levels and with negative real-interest rates, we have a window of opportunity to build the infrastructure of the future, and that will pay for itself.
Finally, one line of thought related to what looks to be the abnormally high level of personal savings. This seems not dissimilar to the glut of savings that was sloshing around the globe in the run-up to the financial crisis of 2008.
With investment at a standstill in an era of lower growth, those funds were competing for return and were believed to be a factor in the lower-than-expected interest rates during that period. The excess demand for return — along with some self-serving observations about reduced risk — led to a housing bubble and fraud and the end of financial stability.
We can turn that savings and interest-rate argument on its head. Because interest rates are now so low, the enormous amount of savings necessary to provide a decent flow of fixed-income returns for retired baby boomers in a pension-free economy suggests upward pressure from the financial crisis of 2008 on the demand for savings.
This argues for a substantial and speedy effort to get the global economy back on its feet so that we can once again start normalizing interest rates. It’s too late for the baby boomers, but Generations Y and Z aren’t far behind.
We should examine the other side of the savings equation: income and spending. The Bureau of Economic Analysis defines personal savings as disposable income minus personal spending.
Personal income in real terms: Inflation-adjusted (real) income was in decline long before the onset of the pandemic in early 2020; it was all part of the unwinding of the industrialization of the U.S. economy after the Great Depression and the Second World War. The rise of cash-funded consumerism (debt fueled spending is another thing) fittingly peaked with Jimi Hendrix’s Woodstock coda in the summer of 1969.
By the end of the next decade, the growth of real personal income had dipped from an average of 4.9% per year to 3.9% per year. And then came the 1980s dismemberment of union representation and the abandonment of traditional industrial areas for the low-cost South. Since 1980, real personal income has grown at an average rate of 3.2% per year.
In the past 20 years, the growth of real personal income began its descent as the manufacturing sector was hollowed out in the aftermath of the Great Recession and employment in the lower-paying service sector became the norm. Since early 2018, that descent turned earnestly linear before freefalling when the economy was shut down in March 2020.
The resurgence of infections and death and the increase in joblessness in the last two months of 2020 coincide with a re-establishment of the 2018-2020 downtrend in income growth.
Personal expenditure in real terms: Personal expenditures grew at an average rate of 4.3% per year during non-recession periods from the 1960s through the 1970s. Though the chart below is compressed (due to the outsized drop in consumption during the pandemic), there has been a substantial drop in the growth rate of spending since 1980 to 3.2% per year.
The decline coincides with demographic changes (the aging of the baby boomers) and economic changes (the loss of manufacturing employment to low labor-cost centers) and technological advances (the automation of repetitive tasks).
Expenditure growth declined during the pandemic by as much as 16% in April 2020, and has recovered somewhat to a decline of 3.3% in December.
Because the consumer sector has become the engine of economic growth, public policy in the pandemic era should be centered on income support for the large portion of households that are unemployed through no fault of their own. Then it should focus on rebuilding the economic, educational and public health infrastructure so it can support advanced manufacturing and higher levels of income and consumption.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.