Connections Between Savings and Output in 2022

The Savings Boom is Over

As the world starts to return to normal the way Americans have saved since the start of the pandemic has changed drastically. At the start of the COVID pandemic savings rate soared to 34% as people stayed home and reduced their spending. As the government boosted the economy to avoid a full blown recession, people were still cautiously spending as many things remained uncertain. As of March, savings rates dropped to 6.2% which is the lowest rate since December 2013. The first three months of 2022 have all been below the pre-pandemic average of 7.5%. Initially this was praised as the economy returning to normal, but now savings rates are dropping at an alarming rate. As inflation rises to record levels, people are dipping into their savings. Incomes are not rising fast enough to keep up with inflation. The higher savings rates of the earlier stages of the pandemic were followed by an increase in output. Now as the savings boom ends the future of the American economy and economies everywhere are uncertain (Hardy, 2022).

In one article we looked at the first large growth periods of the U.S and Japan were looked at with respect to the savings and investment rates. In the United States a residual outward shift in the personal saving function accounted for almost two-thirds of the rise in the net investment rate while in Japan at least one-third of the rise in the ratio of net private investment to national product was due to an unexplained outward shift in the savings function (Suto and James, 1999). High savings rates mean investment is high and when investment is high then firms are growing and expanding leading to increased growth. In both cases these rise in rates were attributed to exogenous factors just as in 2020. The pandemic shifted the way people saved, so when stimulus checks came in and work picked back up people were still saving. Investment then due to this and the low interest rates the economy took off. These circumstances match very closely with those mentioned in the paper where there was record high growth. Unfortunately, the periods mentioned in the paper lead up to the Great Depression. 

As inflation rises and savings decreases at an alarming rate, investment will begin to dwindle. Rate hikes from the FED coupled with money not going as far as it used too could lead to serious trouble. We want the economy to cool off, but we do not want to see the savings rate drop this fast. Uncertainty lies ahead for the American economy and economies around the globe as a multitude of factors move in different directions. Historically we would expect to see drops in output, so this brings to question. Are we knocking on the door of a new recession or while the FED and Congress find a solution to tackle the inflation rates that are damaging savings rates?

Graph 1: We can see the first spike at the beginning of COVID. The savings rate dropped and then spiked again as more stimulus rolled in later in the pandemic. Now rates have returned beyond normal levels due to a rise in inflation. These higher savings rates were periods where output was growing, so this makes us wonder if a large drop in output is coming.

Solow Model

Looking at our Solow models we are seeing our savings function decrease. Now at the same levels of output savings is not keeping up with depreciation and our overall output per work and capital per worker decreases. Is this what is in store for the US economy?