The Pandemic Saving Rate Fueled Inflation
The American consumer may have one more jump scare left for the economy.
Slasher films all tend to end the same way. The murderous psycho has seemingly been vanquished. The protagonists finally can breathe a sigh of relief in a moment of calm. Suddenly, the killer bursts into the scene, showing he’s still viable enough to make a final homicidal plunge.
The killer in our economy was arguably the excess savings built up during the pandemic period. For around 18 months, from the the onset of the lockdowns and attendant economic recession in March 2020 through August of 2021, households rapidly accumulated savings.
The chart below shows the personal saving rate, which is calculated by subtracting taxes and spending from personal income. It jumped from 6.9 percent in the fourth quarter of 2019 all the way to 24.4 percent in the second quarter of 2020. That was the highest rate ever recorded and the biggest jump in data stretching back to 1959. The previous record high of 15.9 percent occurred in 1979.
Importantly, this spike in the saving rate was not short-lived. Saving remained above the pre-pandemic peak in the first quarter of 2019 for seven quarters. That makes it one of the longest periods of elevated saving ever recorded. The increase in saving lasted far beyond the brief recession, indicating that this was very different from the precautionary saving spikes typically seen in downturns.
Where Did Excess Saving Come From?
There were quite a few drivers of this increase in saving. Fear of a severe and lasting downturn no doubt played a role, especially early on. People were stockpiling funds as well as toilet paper, canned goods, and disinfectant in the early pandemic period.
As well, lockdowns and social distancing (both voluntary and required) suppressed spending, especially on recreation, travel, dining out, and many services. Some of this wound up in spending on goods, but a good deal of it just got socked away. How many exercise bikes, tablets, or standing desks could one household buy?
On the other side of the ledger, government stimulus checks and a host of pandemic relief programs inflated incomes while also depressing spending. Households could avoid paying rent without fear of eviction. Student loans were put on hold. Unemployment benefits were super-sized. Paycheck protection program loans to businesses were forgiven.
The Biden administration came to power on the false premise that the economy was in shambles. In fact, it was growing at a rapid pace even before Joe Biden took the oath of office. But instead of allowing the economy to normalize, the Biden administration pushed through a series of huge spending bills that further pumped income into the private sector.
The result of all of this was the accumulation of what economists refer to as “excess savings.” This is a somewhat nebulous concept, but in broad strokes it refers to the additional funds available to households in excess of what they would have had if their savings had not increased beyond normal levels.
Spending down this excess savings was one of the biggest sources of inflation, made even worse by the fact that Americans began to spend their excess savings while supply chains were still snarled. The Fed initially underestimated the impact and duration of this excess spending—leading it to wrongly conclude that inflation would be transitory.
Is It Over?
How much excess savings was built up is a matter of some debate. A critical component of measuring excess savings is the baseline of what would have constituted normal savings. If the baseline is too high, then the amount of excess savings—and therefore the stored up spending power of consumers—will be underestimated.
Federal Reserve officials appear to believe that excess savings have now been depleted. According to a measure created by the San Francisco Fed, excess savings ran dry in March of this year. In fact, we’ve spent more than all our excess savings, according to the San Fran Fed model.
“The latest estimates of overall pandemic excess savings remaining in the U.S. economy have turned negative, suggesting that American households fully spent their pandemic-era savings as of March 2024,” a pair of San Fran Fed economists wrote in a May 3 blogpost.
But their baseline saving rate may be too high—and therefore their estimate of excess savings too low. What the San Fran model appears to assume is that the higher rate of saving that occurred just before the pandemic counts as normal. So, it only counts the savings above that level as “excess.” But if that level was already a sign that households were accumulating “excess savings,” things look very different.
A recent analysis from Bank of America calculated that the personal saving rate averaged 6.5 percent from 2017 to 2019. If that is used as the baseline, then there there still would be excess savings available for spending. By the Bank of America estimate, there is still enough excess saving to support spending through the end of this year.
It May Be Much Larger Than Anyone Thinks
Even this might be too cautious. In the first place, even the 6.5 percent saving rate is high compared to what prevailed in the years before Donald Trump was elected president. Then the saving rate was typically below six percent. In fact, the average saving rate of Barack Obama’s second term was 5.4 percent. If that’s the baseline, excess saving is far higher and could support elevated consumer spending for years to come.
There’s a good argument that the prevailing saving rate today may still be “excessive” given the recent bout of inflation. The last time the U.S. experienced very high inflation in the 1970s, the saving rate plunged and stayed lower for years. This makes sense because people who experienced high levels of inflation and continued to expect elevated inflation would rationally avoid accumulating dollars that were losing their spending power. Better to spend your income right away if inflation is eating away at value of the dollar.
The Fed and many on Wall Street assume that the villain of excess saving has been put to rest. Don’t be so sure.