The consumption impulse from pandemic savings ‒ does the composition matter?

Prepared by Niccolò Battistini, Virginia Di Nino and Johannes Gareis

Published as part of the ECB Economic Bulletin, Issue 4/2023.

Following the outbreak of the pandemic, households in the euro area and the United States accumulated a large stock of savings, in excess of the pre-pandemic trend.^[1] Between the first quarter of 2020 and the fourth quarter of 2022, the accumulated stock of excess savings rose steadily to reach 11.3% of trend (gross) disposable income in the euro area. In the United States, the accumulated stock of excess savings reached 13.2% in the third quarter of 2021, before declining to 7.9% in the fourth quarter of 2022.^[2] Taken at face value, the large stock of excess savings in both economies suggests the possibility of a substantial consumption impulse, defined as the immediate stimulus to consumption from the potential use of these savings. Moreover, it points to a larger remaining consumption impulse in the euro area relative to the United States, where consumption has expanded by considerably more in the post-pandemic period. Besides the size of the stock, the composition of excess savings plays a key role in determining the implied consumption impulse. This box estimates the composition of excess savings and then calibrates a general equilibrium model with heterogenous agents based on the methodology used by Auclert et al. to gauge the consumption impulse in the two jurisdictions.^[3]

Beyond the stock of pandemic savings, the composition of these excess savings matters for two reasons. First, excess savings are allocated across assets with different degrees of liquidity, which is a first (partial equilibrium) determinant of their consumption impulse. Second, the impact of excess savings on the consumption impulse also depends on broader (general equilibrium) dynamics: on the one hand, the dynamic re-distribution of the savings spent by some households to other households prolongs the duration of the consumption impulse; on the other hand, the anticipation by households of this future re-distribution dampens the size of the consumption impulse, as households smooth their consumption patterns over time. Empirical evidence suggests that these partial and general equilibrium effects may play out differently in the euro area and the United States.

Between 2020 and 2022, in the euro area, excess savings were accumulated mostly in illiquid assets, while in the United States these were largely accumulated in liquid assets. In the euro area, between the first quarter of 2020 and the fourth quarter of 2022, excess savings were invested in non-financial assets, such as housing, and in relatively illiquid financial assets, such as stocks and bonds, and were also used to pay back loans. Taken together, these forms of cumulated excess savings rose steadily to reach 10.8% of trend disposable income in the fourth quarter of 2022 (Chart A). By contrast, cumulated excess savings in the (most) liquid financial assets, such as currency and deposits, peaked at 3.7% of trend disposable income in the first quarter of 2021 and then declined significantly to 0.6% in the fourth quarter of 2022. In the United States, the composition of cumulated excess savings at the end of 2022 was remarkably different. Liquid financial assets amounted to 18.5% of trend disposable income, while illiquid assets fell below their pre-pandemic trend by 10.6%, also reflecting a sizeable accumulation of new loans.^[4]

Chart A

Allocation of cumulated excess savings across assets

(deviations from the pre-pandemic trend, percentages of trend disposable income)

Over the past three years the stock of excess savings was increasingly concentrated among wealthy households on both sides of the Atlantic. The analysis of the distribution of excess savings across households combines their estimated allocation across assets, discussed above, with survey information on the composition of household portfolios along the net wealth distribution.^[5] The implied distribution of excess savings shows an ever greater concentration among relatively high-wealth households, in particular in the United States (Chart B). The share of cumulated excess savings held by households in the top 10% of the distribution rose from less than half in the first quarter of 2020 in both economies to almost two-thirds in the euro area and more than three-quarters in the United States in the fourth quarter of 2022. However, the relatively larger share of excess savings among low-wealth households in the euro area does not imply a higher consumption impulse compared with the United States. This is because the excess savings in the euro area mostly consisted of relatively illiquid assets, including housing wealth and loan repayments, which represent an important share of portfolios for households at the lower end of the distribution.

Chart B

Distribution of cumulated excess savings across household groups

(deviations from the pre-pandemic trend, percentages of trend disposable income)

A heterogeneous agent model is used to link the estimated distribution of excess savings across assets and households to their consumption impulse, accounting for partial and general equilibrium effects. The model features three groups of households, corresponding to the bottom 50%, the next 40% and the top 10% of the excess savings distribution. Under partial equilibrium, each group decides what share of excess savings to consume or save in each period based on its marginal propensity to consume (MPC), which is assumed to depend on the asset composition of its excess savings. Under general equilibrium, consumption decisions reflect two further mechanisms. First, the savings spent by some households become the income that is financing consumption for other households. As a result, the impulse on consumption is prolonged and it dissipates only slowly, as excess savings “trickle up” towards high-wealth, high-income households, which have a lower MPC. Second, households anticipate the future expansion in aggregate demand and smooth their consumption on impact, with the implied moderating effect being proportional to the MPCs for each household group.^[6] This incentivises the accumulation of savings and limits the re-distribution of income, thus expediting the trickling up of excess savings and muting the consumption impulse.^[7] In both scenarios, the central bank does not react to the expansion in demand, thus keeping the interest rate fixed. Overall, the potential, model-implied impulse to consumption from the use of excess savings depends on the calibration of two sets of parameters: (i) the MPC for each asset class; and (ii) the share of total income for each group of households (Chart C). The MPC is set to 50% for liquid financial assets and 5% for illiquid assets.^[8] The share of income is calibrated at 9%, 55% and 36% in the euro area and 15%, 36% and 49% in the United States for the bottom 50%, next 40% and top 10% of the excess savings distribution respectively.

Chart C

Marginal propensity to consume across assets and income across household groups

(percentages)

The consumption impulse from pandemic savings has declined in both economies and has been lower in the euro area compared with the United States. Under partial equilibrium, the model assumes that household decisions do not account for the re-distribution of income and the response in interest rates, so that the consumption impulse is only determined by the MPC for each group of households. This is calculated as the weighted average of the asset-specific MPCs, with the weights pinned down by the group-specific portfolios in each period. In this scenario, the consumption impulse significantly declined from a peak in the second quarter of 2021 in both economies, and, consistent with the subdued consumption dynamics, remained relatively weak over the past three years in the euro area compared with the United States (Chart D).^[9] Under general equilibrium, the model simulations point to consumption smoothing having a stronger dampening impact in the United States, reflecting its larger average MPC relative to the euro area. In this scenario, the consumption impulse was moderate in both economies at the end of 2022.

Chart D

The consumption impulse from pandemic savings

(deviations from the pre-pandemic trend, percentages of trend disposable income)

Further considerations reinforce the model-implied results of a moderate remaining additional boost to private consumption from excess savings, especially in the euro area. First, the different origin of the excess savings helps explain the smaller consumption impulse in the euro area compared with the United States. In the euro area, these excess savings were mostly due to mobility restrictions that limited consumption, especially for high-contact services, on which wealthy (low-MPC) households generally spend a larger share of their income. In the United States, the excess savings were mainly due to large stimulus packages that supported incomes, especially for (high-MPC) households at the bottom of the wealth distribution.^[10] Second, recent price developments reinforce the view of a modest remaining consumption impulse from excess savings in both economies. Indeed, the rise in consumer prices and the decline in asset prices in recent quarters, amplified by the ongoing monetary policy tightening and deteriorating financing conditions, further reduce the remaining consumption impulse.