George discusses the implications of the post-Covid boost in household savings resulting from the decrease in consumer spending during lockdown.
The COVID-19 pandemic saw a divergence between the condition of personal finances and the national economy. While the headlines screamed of economic catastrophe, many households, particularly affluent ones, improved their financial situations, accruing savings due to reduced consumption expenditure during periods of lockdown. In the UK, the average savings rate increased from 9% to 26%, the highest on record. This apparent silver lining has important macroeconomic implications for the pandemic recovery and the coming decade as a whole.
A quick glance at the theory prompts to the conclusion that these savings will be invested in businesses, allowing them to expand their operations, and generate income for household lenders, as well as drive economic growth. There also appears to be a degree of pent up demand present in the economy which will be realised by a surge in consumer spending, fueled by savings as the economy reopens. All sounds good.
However, a key caveat to this is that without an increase in production, an increase in either investment or consumption will drive inflation, as more money chases the same quantity of goods. In particular, increased spending on consumption may increase the price of consumer goods, while increased investment could have an inflationary effect on the market for the factors of production, including labour.
In For a Penny
There are signs that increased investment is boosting the recovery of the UK economy, but the evidence is mixed. For one, economic growth has been strong compared to predictions, with GDP figures realising the optimistic scenario from the Office for Budget Responsibility March 2021 forecast, despite delays to the reopening road map announced in February.
Along with strong GDP growth, the record number of job vacancies may suggest businesses are investing. It is not clear, however, whether this can be attributed partially to household savings or whether it simply represents a rebound in demand and a less cautious attitude to COVID than had been expected.
Another appearance made by investment in this post-Covid economy is through new company incorporations. The rate of these has risen by around 30% during the pandemic. This suggests people have the savings and the time to try their business ideas. Overall levels of investment were reduced during the pandemic as businesses scaled back operations, but they have recovered towards pre-pandemic levels since the easing of lockdown. Gross fixed capital formation is 5% lower than in 2019, but it has rebounded rapidly from the 2020 low. Nevertheless, company dissolutions have also risen during the pandemic. This upheaval may help to account for the fact that total investment is yet to return to its pre-pandemic levels.
Perhaps the most compelling evidence for the impact of investment is rising productivity. Workers are more productive when they can utilise more capital, which comes from increased investment. Productivity has risen, with output per worker 1.7% above pre-pandemic levels. Estimates of output per job, excluding furloughed workers, have increased by 7.2%. This rise can be partially explained by the less productive nature of industries which saw large numbers of furloughed workers. It may also be partially accounted for by the decrease of the workforce which leads to more capital being available per worker. Some of the increase in productivity has been sustained into the recovery though, so it is possible this is due to increased investment in capital arising from a surge in household savings.
Given that the economy has contracted significantly, it is surprising that households are better off. One way to resolve this apparent contradiction is inflation. UK inflation has already risen to a 9 year high, but what is particularly interesting is the sectors that are driving inflation. These can be classified into sectors that are rebounding and sectors in which extra savings have encouraged more people to enter the market, despite them not being depressed in the first place. Sectors in which people are not spending excess savings and demand was not significantly reduced by COVID have seen little inflation.
On the consumption side, unsurprisingly, sectors that were particularly negatively impacted by COVID have rebounded. Hotels and transport have both seen high inflation at 8.6% and 7.8% respectively. This is driven by demand recovering after a reduction last year. Travel restrictions prevented booking and nerves around COVID meant many people preferred to stay at home. Savings certainly play a role in realising pent up demand. Restaurant diners are up on the equivalent week in 2019 by around 20%, but were almost 80% higher immediately after reopening.
Two Sides of the Same Coin
It is striking how unequally the increase in savings has been distributed. In the highest-earning quintile, 47% of households saw their savings rise, compared to just 12% in the lowest-earning quintile. In fact, 32% of this group have seen a decline in their savings. A House of Commons report said, “groups which are more likely than average to have taken on more debt since the start of the coronavirus pandemic include renters, people from minority ethnic groups, parents and carers, disabled people and those who are shielding, and young people.”
While the source of savings is relatively unimportant for investment, it is consequential for changing consumer spending patterns and influencing which markets experience inflation. Markets that require a high level of savings before entry, such as luxury goods and housing, have seen quick inflation with the present surge in savings. Given the savings of the pandemic have mainly accrued to affluent demographics, it is unsurprising that goods fitting their tastes have seen particularly quick inflation. House price inflation in the UK has risen to 13% up from 2% before the pandemic, which can be attributed to a rise of speculative home investors with a lot of spare cash.
Another case of this is stock trading and cryptocurrency. In general, people require savings they can afford to lose before they will trust themselves on the stock market. Increases in household savings with little available spending outlets, coupled with the recent ease of retail investing can cause market anomalies such as the GameStop and cryptocurrency bubbles. This cannot be considered investment, in the sense set out by the neoclassical paradigm, as any profit will come at someone else’s expense.
In contrast, sectors where demand has remained relatively constant, and where people are unlikely to spend excess savings, inflation has remained low. One example is food where inflation has been a mere 0.3%.
My Two Cents
Both the rise in inflation and the rise in investment are also influenced by other factors. Many supply chains have been disrupted putting upwards pressure on inflation, compounded by other exceptional circumstances often related to the pandemic and tightening supply. For illustration purposes it is worth considering the recent gas shortages. A lack of storage, a particularly cold winter in 2020, as well as higher demand due to reopening business has led to surging prices, pushing gas firms out of business. Investment, on the other hand, has also been boosted by consumption exceeding its pre-pandemic levels.
The evidence seems clear that savings are driving inflation, particularly when considering sector by sector inflation. This suggests a surge in inflation will be temporary, but it is possible that high inflation figures will erode confidence in the currency, leading to the propagation of inflation across the economy. Rising wages will also accelerate cost push inflation across the economy, but it seems probable that inflation will end when savings are exhausted and, of course, increased inflation will bring that about quicker.
When it comes to investment, the evidence is less definitive, but it seems likely that savings have had a role to play in quicker-than-expected growth. With high inflation, it seems any boost to investment will also be temporary, as households spend their excess savings before returning to their previous spending habits.