European Central Bank senior economists Johannes Gareis (left) and Niccolò Battistini (right) stated, “Higher interest rates make it less attractive to hold cash and bank deposits. Instead, households bought higher-yielding financial assets, borrowed less or repaid loans,” indicating a reluctance in euro area household spending. Photos: European Central Bank; Montage: Maison Moderne

European Central Bank senior economists Johannes Gareis (left) and Niccolò Battistini (right) stated, “Higher interest rates make it less attractive to hold cash and bank deposits. Instead, households bought higher-yielding financial assets, borrowed less or repaid loans,” indicating a reluctance in euro area household spending. Photos: European Central Bank; Montage: Maison Moderne

Euro area households saved €1trn during the pandemic, mainly held by wealthier households in illiquid assets, dampening expectations of a quick consumption surge and impacting inflation and the European Central Bank’s monetary policy response.

Between the end of 2019 and the second quarter of 2023, households in the euro area collectively saved approximately €1trn more than they would have under normal circumstances, according to a study conducted by senior economists Niccolò Battistini and Johannes Gareis at the European Central Bank.

However, prevailing macroeconomic conditions have prompted households to shift these excess savings towards illiquid assets, rather than increasing consumer spending post-recovery, as noted in a publication on 2 November 2023. This shift has had a direct impact on euro area inflation and is consequently of significant interest to ECB policymakers.

The ECB experts asserted that the €1trn in excess savings, representing about 12% of the euro area households’ annual disposable income, is a direct consequence of the pandemic’s disruptive effects, which restricted spending on activities such as dining out and travel. Additionally, government subsidies provided further financial assistance to households during these challenging times.

According to the economist duo, excess savings began to accumulate shortly after the onset of the pandemic, with the second quarter of 2020 marking a significant turning point. This period witnessed a pronounced decline in consumer spending relative to pre-pandemic levels, although fiscal transfers to households also increased, albeit to a lesser degree.

In 2022, soaring inflation became a significant issue, increasing the cost of goods and services. Despite this, private consumption in nominal terms surpassed pre-pandemic levels, but the overall amount of excess savings remained stable, as rising incomes compensated for the increased consumption.

Battistini and Gareis found that excess savings primarily accumulated during the first two years following the onset of the pandemic, which then led to a phase of stagnation. For them, this pattern suggests that households are currently holding onto their excess savings.

Excess savings allocation

While households may keep their savings in cash or bank deposits, which are readily accessible for spending, they could alternatively choose to repay loans or invest in less liquid financial assets like equities and bonds, or in non-financial assets such as housing and property. The ECB economists discovered that following the outbreak of the pandemic, euro area households initially directed the majority of their excess savings into cash and bank deposits, as well as other financial assets.

However, in 2021, the amount of savings held in cash and deposits fell below the pre-pandemic trend, while investment in other financial assets continued to climb. A similar trend was observed in housing investments, albeit to a reduced extent.

This shift in allocation has intensified recently, potentially as a response to rising interest rates, which have rendered cash and bank deposits less appealing. Instead, households have demonstrated a preference for higher-yielding financial assets or have opted to reduce borrowing and increase loan repayments.

Excess savings distribution

The distribution of excess savings across income groups is also noteworthy. Battistini and Gareis revealed that households in the top 20% of income distribution hold approximately half of the total excess savings, while those in the bottom 20% own less than a tenth.

This disparity is consistent with previous analyses indicating that wealthier households were less affected by income losses during the pandemic. Furthermore, these more affluent households, navigating through the macroeconomic landscape altered by Russia’s war in Ukraine and the ECB’s hawkish monetary policy, have channelled their excess savings into illiquid assets.

Aptly put, the ECB economists concluded the study with “those hoping that the money put aside during the pandemic will support a surge in consumption any time soon will likely be disappointed.”

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