How rampant is spending about to get?


The British government on Monday delved into the detail of its plans to ease economic and social restrictions in the coming months. A day later, we’re seeing anecdotal reports and market movements that signal we’ve become very excited that we’re about to see pent-up demand unleashed.

Dropping caseloads and vaccinations permitting, economies are set to reopen soon. When they do, we will undoubtedly see a wave of spending on things like holidays and restaurants. But just how much spending will there be? And how much inflation will it bring with it?

It’s worth reading what Bank of England policymaker Gertjan Vlieghe had to say on this topic on Monday. His thinking leads us to the view that it really depends on which side of the Atlantic you are.

His arguments focus on the well-known trend for the less well off to spend a greater proportion of their income than those who earn more. Or, as is it is known in econspeak, people’s marginal propensity to consume which tends to be higher the lower down the income scale they are.

Vlieghe notes that, due to the less well off taking a greater hit to their income than in the year to September 2020, savings rates have increased primarily among those who tend to spend less of their income:

This, he says, will probably lead to a less drastic rise in spending than if the impact of the pandemic had been more broadly felt (our emphasis):

To what extent these savings will be spent once social restrictions and voluntary social distancing are eased is highly uncertain. The propensity to spend out of wealth is estimated to be quite small, with international estimates centred around 5 per cent. That would suggest a boost in the level of consumption of around 1 to 1.5 per cent . . . 

. . . The propensity to consume out of additional income, rather than wealth, is significantly higher than that, with estimates ranging from 10 per cent to 50 per cent. But the higher estimates relate to households that have low income or low liquid assets. The households that have actually accumulated the savings last year have both high incomes and are likely to have high liquid assets, so would tend to have a lower propensity to spend.

In the US, however, this isn’t so much the case. While the UK opted to give furloughed workers up to 80 per cent of their salary, the US granted blanket support across the income scale in the form of stimulus cheques and helped the worst hit with more substantial increases in unemployment benefits. That support was so great that disposable income actually rose in the aggregate in the US and was more evenly distributed. The result of which, in chart form, looks a little like this:

This would mean that one would expect more pent-up demand to emerge in the US. Even before one considers that a substantial chunk of the proposed $1.9tn fiscal stimulus plan is in the form of stimulus cheques, and expanded and extended unemployment benefits.

This demand would usually lead to higher prices, especially in an environment where supply capacity may have been destroyed by business closures. Which is perhaps why the likes of Larry Summers and Olivier Blanchard have cautioned that the plan could stir up price pressures.

Others have played down the impact this is likely to have on inflation in the longer term. Including Fed chair Jay Powell, who said on Tuesday that, while inflation would be a bit volatile this year — partly because of “upward pressure on prices when the economy reopens”, the pressures would not be “large or persistent”. The fundamentals of inflation did not “turn on a dime”, he said, adding that one fiscal stimulus would not change the dynamics in a way that would lead to prices spiralling out of control.

Disagree with Powell and think that we’ll be splurging upwards of $1,000 to drink a single piña colada on a beach somewhere hot and sunny come summer 2022? Comments in the usual place.

Related links
The illusion of wage growth could haunt the Fed — FT Alphaville
No, inflation isn’t back — FT Alphaville
How hidden is inflation? — FT Alphaville
Inflation is higher than the official numbers — FT Alphaville
Inflation readings are about to get fuzzier — FT Alphaville


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