Household Savings Collapse Sparks Recession Fears Among Economists

While Americans had built up savings at an unprecedented rate following the pandemic, households are struggling to put money away this year—a trend that has fueled fears among economists of an incoming recession.

During the COVID-19 health emergency, when many across the country were forced into lockdowns and the national economy suffered a shutdown, people's personal savings thrived, with people saving as much as 30 percent of their monthly income and having $2.3 trillion in excess savings between 2020 and 2021, according to the Federal Reserve.

For context, it should be noted that these excess savings were concentrated in the top half of households by income, while many lower-income households struggled to make ends meet.

Three years later, the rate of savings among American households is rapidly falling. In February, the U.S. personal savings rate was estimated to be around 4.6 percent—much below the decades-long average of about 8.9 percent, according to the Bureau of Economic Analysis. But what does this mean?

Some economists think that the collapse of household savings could lead to a spending slowdown and trigger a recession. Consumer spending currently represents about 70 percent of the U.S. GDP, a crucial factor influencing the country's economic growth.

"Don't see a Recession? It's Last Call at the bar," tweeted housing analyst Amy Nixon, sharing recent data from Wells Fargo showing how personal savings has collapsed in the U.S. "The smart people have already paid the tab and gone home. The remainder will wake up tomorrow with regrets," she added.

"My intuition and common sense says there's not a bottomless pit of savings to support this level of spending, and there's not a bottomless pit of wage growth to keep it elevated enough to drive GDP indefinitely," Liz Young, head of investment strategy at online bank SoFiYoung, wrote in a recent article about the topic. "Time will tell, but I still believe something's gotta give."

Up until now, the recent growth of inflation and the Federal Reserve's attempts to curtail it by raising the bank's key interest rate in 2022 and this year have not curbed household spending by as much as expected. That's because Americans had a lot of savings accumulated during the years of the health emergency they could burn through.

Now, these savings are starting to dry up, as inflation remains relatively high at 4.05 percent in May despite having cooled down compared to its peak of 9.1 percent in June last year. On top of that, wages haven't grown much at all in recent years, staying much behind inflation.

"U.S. consumers are saving their income at a lower rate than they were pre-pandemic," economist Shannon Seery of Wells Fargo told Newsweek. "This is allowing them to spend more in the near-term, but likely comes at the expense of future growth."

By saving less today, Seery said, "households have been able to continue to spend at elevated rates and that sustained level of demand is helping stave off a U.S. recession." But, she added, "acquiring less in savings will ultimately leave U.S. households more vulnerable to economic shock and could potentially position them worse off during an eventual economic contraction."

It's not only inflation contributing to putting more economic pressure on Americans.

Policies like the suspension of student loan debt repayments are coming to an end, with the Supreme Court having struck down President Joe Biden's plan to forgive the debt for tens of millions of Americans last week. Interest on student loans will resume on September 1, 2023, and borrowers will have to start repaying their debt in October.

The increasing pressure on Americans' pockets can be seen by the fact that people are spending more on their credit cards.

"American consumers have been actively using their credit cards to navigate costs associated with inflation," Melissa Lambarena, credit cards expert at NerdWallet, told Newsweek.

"Rising prices have led some consumers to rely on their credit cards to make ends meet. We're now at a point where credit card debt is at an all-time high, and the elevated cost of interest rates has only added to their debt burden."

As this might not be a sustainable practice, economists expect to see a sudden reduction of household spending by the end of the year.

"Excess savings, or the amount of savings accumulated throughout the pandemic that was in excess of pre-existing liquidity levels, continues to get drawn down. Credit conditions are also tightening and the moratorium on student loan payments is soon ending," Seery said.

"All of these factors position for weaker consumption, but when thinking of near-term recession risks it is the state of the labor market that matters for households. Our base case expectation is that the labor market will continue to only gradually moderate and the slowing in real income will weigh on spending early next year, helping usher in a mild U.S. recession."

Wells Fargo expects the U.S. to fall into a mild recession at the start of 2024, unless the labor market weakness takes longer to materialize or broaden. In that case, "households will likely continue to spend at elevated rates, which could stave off U.S. recession," Seery said.

Other economists are less fearful, or less pessimistic. In an 'Economic Letter' published by the Federal Reserve Bank of San Francisco, economists Hamza Abdelrahman and Luiz E. Oliveira point out that estimates suggest that "a substantial stock of excess savings remains in the aggregate economy," which would shield the country from a recession and support personal spending at least into the fourth quarter of 2023.

According to the economists there's still $500 billion of aggregate excess savings in the U.S. economy.

They specify that things may change if "households have developed a preference for higher savings, significantly shifted their spending patterns, or substituted other sources of income for the expired pandemic-era cash inflows."

Update 7/4/23, 2:50 a.m. ET: This article has been updated to include a comment from Wells Fargo's Shannon Seery.