02 Sep 2021
Keith Wade, Chief Economist & Strategist
The release of pent-up demand as households spend savings accumulated during lockdown could have important implications.
As the US economy re-opens one of the key drivers of the recovery is expected to be the release of pent-up demand from households as they spend the savings accumulated during lockdown. An estimated $2.3 trillion has built up since the pandemic hit the US last year, equivalent to around 13% of household disposable income.
Not all of this will be spent as households will leave some in bank accounts, pay down debt or add to their investments. Nonetheless, there should be a substantial boost to consumption which, as the largest component of national income, should help take GDP growth over 6.5% this year.
On the basis of surveys and our own analysis we estimate that households will spend around 40% of their excess savings over the next two to three years. Such an assumption is in line with surveys such as those by YouGov which suggest 46% intend to spend some of their extra savings and 26% wish to consume half or more of them.
While welcome for the economy and jobs, the release of pent-up demand has the potential to create a ‘boom and bust’ scenario for the consumer and the economy.
Our forecasts are based on the view that households will run down a significant part of their excess savings and then return to the rate of savings seen before the pandemic. That would imply a period where the savings rate falls sharply over the next year and then builds back up again. This has the effect of first driving consumption strongly, before leading to a period of weakness. For example, we could see real consumption growth of 7% this year, followed by only 1.5% in 2022.
The pattern is somewhat exacerbated by fiscal policy as tax cuts and enhanced benefits have boosted household incomes in 2020 and Q1 this year. Spending took a big jump up in March as president Joe Biden’s American Rescue Plan came through. Going forward though, the US consumer faces something of a fiscal cliff as benefits are withdrawn. Further stimulus is coming, but at this point will be more focussed on investment and infrastructure than payments to households.
On this view we see an outlook where initially the run down of excess savings will help cushion consumer spending as benefits fade. As this too runs its course, however, consumer spending should cool significantly in 2022.
Of course, there is considerable uncertainty over this outlook. Our analysis assumes that excess savings have built up evenly across the income spectrum, whereas we know that higher income households (frequently working from home in well paid service sector roles) have tended to gain more. The marginal propensity to consume of this group tends to be lower than average and so would tend to temper the fluctuations in consumption. Many could just permanently add their excess savings to their existing wealth.
More immediately, a potential boom could be stifled by higher inflation. The service sector is struggling to re-open quickly enough to meet the increase in demand as hotels, restaurants and others report shortages of labour and difficulty re-starting. The latest CPI inflation numbers saw significant jumps in prices in these re-opening sectors as firms responded to excess demand.
Meanwhile, the manufacturing sector, which has largely continued to operate at high capacity (helped by online sales), has hit shortages of key components such as semi-conductor chips. It is also having to pay more for commodities and transportation. This is leading to bottlenecks, higher prices and waiting lists for products, delaying stronger expenditure.
Surveys of consumers such as those conducted by the University of Michigan show that higher inflation is adversely impacting confidence and will reduce real disposable income and spending.
Finally, travel restrictions may limit the pick-up in spending. It seems likely that many will want to use their excess savings on a holiday but are limited by ongoing restrictions particularly for international travel. This element of pent-up demand may not be realised for some time given the spread of the delta variant.
Overall though given the scale of excess savings/pent-up demand it seems likely that we will see significant fluctuations in consumer spending driven by shifts in the savings rate. Our central assumption that less than half the excess savings finds its way into consumption still generates considerable volatility in spending.
Such volatility is unusual as for most of the past decade consumption has moved in line with gradual changes in real incomes with fluctuations in the savings rate playing only a minor role. However, the household sector will be looking to return savings toward equilibrium, or a more normal level and make up for lost time during the pandemic. This year could be the strongest year since 1973 for consumer spending, followed by one of the weakest.
All of which makes for a challenging outlook for business and policymakers. Firms will have to take a view on whether the increase in demand is temporary or permanent and whether to adjust prices or add capacity. Central banks will have to decide whether to lean into the initial boom and tighten monetary policy, or wait for a slowdown.
If such key actors misjudge the sustainability of demand, such an environment creates the risk of over-production or over-tightening and will only exacerbate the economic cycle.
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