Across the OECD, forecasts have been revised repeatedly this year to predict higher inflation and generally lower growth. As well as the supply shock from the war in Ukraine, there are other factors in play too. One is the run-down of the ‘excess savings’ that were built up during the pandemic thanks in part to the exceptionally large transfers from governments to consumers and companies. The recovery in 2021 was extremely rapid, mainly fuelled by those transfers. The slowdown in 2022 suggests that the growth impact of these transfers might have come to an end – surprisingly swiftly, judging by the pattern of downside growth surprises so far this year.
Part of the reason why the excess savings have not had a larger or longer-lasting impact on aggregate demand is because of how they are distributed, with the largest portion (in dollar terms) accrued by the highest income quartile. As a rule, the higher your income, the smaller is the proportion of it that you spend. And something similar is generally observed when it comes to ‘windfall’ shocks to income, like the government transfers. So, on the face of it, the more that excess savings from pandemic transfers are accrued by the higher income groups, the lower the expected marginal propensity to consume.
However, the story is actually more nuanced than that. The excess savings accrued by the richest quartile were not in fact built up thanks to the transfers, which were small relative to their income. Instead, they were accrued thanks to lower spending than usual, probably because many opportunities to spend were not available. The impact on aggregate demand now that those opportunities have returned might well be different.
It is hard to be sure how much of those excess savings will now be spent, or over what period. The normal assumption in most macroeconomic models is that in the long run, consumer spending increases in proportion with income – so a 10% increase in income will lead to a 10% increase in consumption. Now, remember that the excess saving built up during that period was a one-off rather than a permanent increase in income. A rational consumer would consider how much lifetime income had increased and spread that windfall across their future income. The impact on their projected annual income and hence additional annual consumption would be tiny. It turns out in most studies though that consumers do not behave ‘rationally’ in that way, but are much more myopic. The extreme alternative is that consumers behave as if their annual income had increased permanently by the level of the excess savings. In that case, consumer spending would increase in proportion with income, and there would be a far bigger impact on consumption than lifetime smoothing would imply.
Fathom’s baseline assumption is in the middle. We think half the ‘excess’ saving will be treated as income in the first year, across all income groups; and more of that will be spent at the lower end of the income spectrum, less at the higher end. Zooming in on the highest income quartile specifically, that is consistent with around $300 billion of the $1 trillion in excess savings for that group being spent within the first year – about half of that income group’s usual marginal propensity to consume out of income.
But the story does not end there. Over the same period, there has been another shock affecting that group: the shock to financial wealth. Since the start of 2022, some $7.1 trillion (around 18%) has been wiped off the value of the S&P 500. Fathom’s proprietary macroeconomic model suggests that a 17% reduction in financial wealth would result in a 1.3% reduction in consumer spending, with the bulk of that change occurring within the first four years. Additionally, since the bulk of financial wealth is owned by the highest income quartile, the impact on their spending must be larger than for other income groups – perhaps two or three times as large.
A reasonable assumption would be that consumer spending by the highest income quartile will decline by around 2% to 3% in the first year after a market shock like this one. It turns out that 2% to 3% of consumption of the highest income quartile is around $200 to $300 billion a year. In other words, the net impact of excess savings and a reduction in financial wealth for the highest income quartile in the US is probably close to zero. We should not look for much support for growth from that part of the population. Instead, any support to consumer spending from excess savings will be likely to come from the third and second income quartiles, where the dollar quantities are large enough to matter and the hit to financial wealth is probably smaller. Consumers are also facing significantly higher prices, though, meaning that the real impact of this spending on growth will be more limited.
High-frequency indicators support this assessment of high earners’ spending. Mobility around retail and recreation venues is still some 10% below its pre-pandemic level in both the US and the UK, while it is close to its pre-pandemic level in the euro area. These are among the activities that the higher income groups held back on during the pandemic, and they are now flatlining below the pre-pandemic level. PMIs in the service sector are also pointing to a contraction in activity across all three of these economies.
All of this suggests to us that without substantial support from macroeconomic policy, a recession in the US is now looking increasingly likely. And that support is unlikely to be forthcoming, with the Fed signalling further rate hikes to come, despite the slowdown in inflation in October.
The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.
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