February 17, 2023 | 12:54
Can Surplus Savings Save the Expansion?
Can Surplus Savings Save the Expansion?
Last week’s Focus publication discussed the inflationary impact of the substantial amount of liquidity in the financial system. This week, we zero in on the largest component of this liquidity: excess household savings . Due to this buffer, many analysts, including ourselves, think the U.S. and Canadian economies will avoid a hard landing, despite more than four percentage points of policy rate hikes in under a year. However, the unequal distribution of savings will also impact the economy, lenders, and retailers.
How much excess savings are left and how long will they last?
U.S. and Canadian households racked up vast savings in the pandemic amid spending restrictions and fiscal largesse (Chart 1). By our estimate, American households acquired extra savings of more than $2.4 trillion by the fall of 2021. Up to that point, households were socking away income at rates well above the pre-pandemic five-year mean of 7.6%. But, as they began tapping this cash reservoir, the saving rate slid to near-record lows of 2.4% in September 2022, before turning up modestly. As a result, excess savings shrank by a third to roughly $1.6 trillion, still a substantial 9% of after-tax income. Most of it appears to be sitting in bank deposits and money market funds (Chart 2). The cumulative drawdown since the fall of 2021 was equivalent to about 3% of nominal GDP, providing a solid backstop to spending in the face of high inflation and rising loan costs.
At current rates of depletion, excess savings could shrink to $0.8 trillion by year-end, a net drawdown of two-thirds from the peak in 2021. This would support nominal GDP to the tune of about 3%. Moreover, it would leave a similar amount available to buffer demand in 2024. Even allowing for a higher “normal” saving rate than in the five years before the pandemic—say 9.0% as per the mean since 1959—due to the desire to hold extra liquidity given uncertainty about inflation and interest rates, some excess savings would persist until early 2024 at current rates of spending. A somewhat faster depletion would likely occur if student loan repayments resume this summer.
In Canada, although the personal saving rate plunged from a record 26.5% in 2020Q2 to 5.7% in 2022Q3, it remains well above the 2015-2019 average of 2.2%. This means households are still acquiring excess savings, estimated at $340 billion or a massive 23% of disposable income. Even allowing for a higher normal saving rate than in the five years before the pandemic—say 7.7% as per the mean since 1961—some excess savings would persist for six more years at current rates of spending. As in the U.S., the lion’s share of the surplus cash appears to be parked in bank deposits, though a large amount was likely used for purposes other than consumption, notably to invest in term deposits (Chart 3). Monthly data suggest that notice and demand deposits held at banks turned down late last year.
Who holds the excess savings?
In the U.S., the Distributional Financial Accounts show that bank deposits held by mid- to upper-income households rose sharply early in the pandemic and remained high through the third quarter of 2022 (Chart 4). By contrast, deposits held by the two lowest income quintiles largely tracked the rising trend in place prior to the pandemic, one that benefited from a strong labour market and personal income tax cuts. Lower-income earners now appear to have tapped most of their excess funds to satisfy pent-up demand and cover the rising cost of necessities, such as food, fuel and shelter. A Federal Reserve study (October 21, 2022) found that the bottom half of income earners held about $350 billion (or roughly $5,500 per household on average) in excess savings as of mid-2022, while the top half held $1.35 trillion. The lowest income quartile held about a third of the lesser amount.
In Canada, the Distributions of Household Economic Accounts show that the rising cost of necessities took a severe toll on the ability of low-income earners to save. For the bottom 40% of income earners, net savings shrank by 12% between 2020Q1 and 2022Q3, contrasting with a 34% increase for the second-highest income quintile and a 21% advance for the top income group. A Statistics Canada study (February 8, 2023) found that 63% of Canadians in the lowest income quintile were very concerned about covering daily expenses, largely due to the high cost of food, transportation and shelter.
Implications for the economy, lenders, and retailers
Savings allow consumers to smooth spending in the face of income and wealth shocks, adding resilience to the economy. Despite draining a large portion of their cash hoard, American households have a substantial buffer left to cushion an expected downturn and lend support to the subsequent recovery. However, because the excess savings are now mostly held by upper-income groups that have a lower propensity to consume, the cushioning effect will diminish. In fact, after drawing down most of their cash buffer, low-income earners could increase precautionary savings if the economy slumps and job insecurity rises. They could also struggle more than other groups to maintain bill payments and service debt.
In a reversal of pre-pandemic trends, Canadian households are now saving more than American families, likely because they need to service a larger debt burden (Chart 5). For the one-third of Canadian households with a mortgage, many are likely setting aside extra funds to cover the thousands of dollars of additional annual payments come renewal time. This is much less of a concern for most U.S. mortgage holders with long fixed-rate terms. Despite holding substantial excess savings, Canadian households are likely to allocate a greater share to repaying and servicing debt, which will help limit defaults but lessen support to the economy.
For retailers, spending on luxury goods and leisure-related services could remain buoyant given the sizeable excess savings held by upper-income groups. Here, retailers may retain some pricing power even as the economy sours. By contrast, sellers of lower-end discretionary items will likely face a more cautious customer. Notably in the U.S., real consumer spending on goods remains well above the pre-pandemic trend-line, suggesting scope for cutbacks.
Bottom Line: A large reservoir of household savings should backstop spending for another year in the U.S. and even longer in Canada, shielding the economy from the full effects of restrictive monetary policy. While this firepower is more likely to delay than avert a mild downturn, it could help the economy resume growth by next year. However, the savings buffer could be a double-edged sword if it sustains high inflation and triggers even tighter policy. Moreover, a thinner cash cushion for lower-income groups means they are more susceptible to a slowing economy.
 Businesses in both countries have also acquired substantial savings based on current cash balances, which will support investment and other forms of business spending. But consumers carry the most sway in the economy; if they cut spending, businesses are likely to preserve cash balances. In addition, due to the rapid economic recovery and federal financial aid, U.S. state governments are holding a record amount of rainy-day reserves equivalent to about 0.5% of GDP, according to the National Association of State Budget Officers. [^]