Update 528 — From Saving to Spending:
The Consumer’s Role in the US Recovery
Consumer spending comprises 70 percent of GDP, so big changes in consumer behavior bear directly on growth more than any other factor. Per the Bureau of Economic Analysis, total personal income in the U.S. increased $4.21 trillion in March. This 21.1 percent increase was the largest monthly jump in personal income since at least 1959. But consumer spending increased by only $616 billion — a 4.2 percent increase.
The statistics suggest that the economy is slowly emerging from the pandemic recession. But big unknowns remain. How much pent-up demand is there among consumers? How has the pandemic altered consumers’ economic behavior, and what role will consumers play in fueling the recovery? Below, we explore those questions and the impact of federal stimulus policy on consumer activity.
Good weekends all…
COVID and Consumers: Long-Term Impact?
The pandemic significantly altered Americans’ spending habits. Following the initial outbreak last year, U.S. consumption declined sharply. With restrictions on activities and certain business operations, consumers had fewer services to spend money on. The unemployment rate ballooned from 3.5 percent in February 2020 to 14.8 percent in April. In 2020, Americans spent over half a trillion dollars less on goods and services than in 2019, causing 2Q21 GDP to decrease by 31.4 percent. Yet personal disposable income increased significantly in 2020, indicating a large shift toward savings. Savings rose to historic highs during the pandemic. With Americans cutting back on spending, middle- and upper-income households, in particular, saved more money than any year in recent history.
The story has been different for low-income households. After the first round of stimulus checks from the CARES Act, overall spending increases were largest among low-income individuals. Low-income households cut their spending less than high-income households did in the early part of the recovery; spending by low-income households returned to pre-pandemic levels in September 2020, with spending by high-income households lagging behind.
The recession has exacerbated the country’s existing income and wealth inequities, with low-income individuals not having the financial wherewithal to save or fall back on savings, while being more likely to lose their jobs and needing to borrow money to stay afloat.
Changes in spending patterns have been uneven across economic sectors, as consumers have adjusted their purchasing behavior to pandemic-related restrictions. Declines in consumption are concentrated heavily in the service industry, yet consumption in goods has had only modest and in some cases non-existent declines. Consumption in food services and accommodations decreased by $186 billion. Transportation spending fell $174 billion, health spending, $148 billion, and recreational consumption has declined by $86 billion. But spending on insurance, retail food and drink, housing, utilities and gas have all seen little or no negative impact in pandemic-era consumption.
Personal Consumption Expenditures, 2019-20
Source: Federal Reserve Bank of Kansas City
Economists expect that services like air travel, hotels, restaurants, and movie theaters will bounce back significantly in 2021. However, certain industries may take several years to fully recover, and many closed business operations will not return all. Anxiety around large crowds is partially responsible for the significant portion of Americans who believe the pandemic has permanently changed their spending habits. Consumers will likely continue to rely more on grocery services like Instacart and Amazon Fresh, telework, contactless services, and online shopping for some time.
Consumers’ Role in the Recovery
Many economists expect a strong economic comeback from the recession this year, with the Federal Reserve predicting a 6.5 percent increase in GDP in 2021. If so, the current recovery would be much faster than the previous recession’s, which took several years to complete. As the pandemic abates, consumers will have more opportunities to spend on services that they may have been holding back on due to health restrictions in place or general uncertainty — leading to a faster recovery.
Recent economic data suggest that this is beginning to take place. Consumer sentiment in April rose to its highest level since the beginning of the pandemic, and consumer spending, as noted above, increased at a strong clip in Q1 2021. Wages and salaries increased by one percent in Q1 — up 2.7 percent since last March — giving consumers more disposable income. Retail sales, which took a significant hit in 2020, were up 9.8 percent in March, with the restaurant and travel sectors seeing strong spending in Q1.
How much pent-up demand is there in the economy? Spending on services continues to lag behind pre-pandemic levels, and as economist Jason Furman has pointed out, it is still unclear whether individuals will take more vacations or eat out more frequently this year to make up for lost services during the pandemic.
A factor that will play a key role in consumer demand this year is savings. Personal savings totaled $6.04 trillion in March — up by around $5 trillion since February 2020 — and the personal savings rate spiked to 27.6 percent. The effect of this savings boom by consumers remains unclear. The accumulation in savings has been driven by the highest income earners, and since wealthier individuals are more likely in general to save more as a percentage of their income, the money saved up during the pandemic could be spent slowly. The opposite outcome could also result, since the savings buildup has been largest among older wealthy individuals — a group that is mostly vaccinated and has a higher propensity to spend on hospitality and leisure.
Checking Deposits by Income Group
Source: Federal Reserve, graph produced by the Wall Street Journal
Federal Stimulus and Consumer Behavior
Of the $4.2 trillion increase in household income in March, stimulus payments from the American Rescue Plan (ARP) accounted for about $3.95 trillion. The positive effects on consumption from enhanced unemployment benefits and direct stimulus payments, delivered through the CARES Act and American Rescue Plan, cannot be understated. During the Great Recession, it took 23 months for personal consumption to reach its pre-financial crisis levels. However, even in the midst of on-and-off lockdowns, personal consumption fully returned to pre-pandemic levels after only 14 months.
Aggressive federal policy to put money in the pockets of families paid off, with consumer household spending increasing by $546 on average in the initial two weeks of CARES Act stimulus payments. Based on Federal Reserve survey data, the cumulative effect of multi-round stimulus payments alone increased consumer spending by at least $228 billion.
As Congress pivots away from immediate relief and toward infrastructure policy, the success of the CARES Act and ARP demonstrates the need for Congress to go big to support consumers in the long term. Over the past 20 years, while consumer goods prices increased by only 50 percent, the costs of childcare rose by 100 percent and the cost of four-year college by nearly 250 percent.
Congress can alleviate spiraling costs of childcare and higher education with direct investments, as proposed in President Biden’s American Families Plan. Additionally, Biden’s proposal to permanently expand the Earned Income Tax Credit and keep the Child Tax Credit fully refundable would provide a direct cash benefit to low-income families, who are most likely to use the money on consumption rather than putting it into savings.