By Ludovic Subran
MUNICH – The COVID-19 pandemic is a crisis like no other. In 2020, it plunged the global economy into its deepest recession since World War II. But, after a year in the doldrums, Europe’s private firms and households are now awash with cash. How households, in particular, use their accumulated savings will be crucial in shaping the continent’s post-pandemic recovery.
Whereas companies have built their cash buffers on piles of new debt, households remained prudent during the pandemic: Their debt barely increased, and debt leverage remained essentially flat. Households’ cash buffers – or excess savings, as they are often called – stem from reduced spending, mainly on services. All those canceled restaurant meals, holiday trips, and concerts swelled European household savings by €450 billion ($534 billion) in 2020 alone. And renewed lockdowns in the first half of this year could add another €200 billion to the total in 2021.
True, Europe will experience an economic rebound this year regardless of what happens to the excess savings. But how households deploy them will help to determine whether the recovery merely marks a return to the pre-crisis growth path, with all its social dislocations and political blowback, or instead ushers in a new era of inclusive and sustainable prosperity.
Households certainly will use part of these savings for consumption, as the reopening of economies this year releases pent-up demand. But the boost might be smaller than some observers expect. For starters, much of the excess savings have been accumulated by richer households, whose income remained stable during the pandemic and who have a relatively low propensity to consume.
Moreover, most European households will regard excess savings resulting from lower consumption as a positive “wealth shock,” with the wealth effect on spending at the aggregate level being rather low as households may remain cautious about the lasting effect. In the United States, by contrast, excess savings were fueled mainly by generous income support for all households in the form of lump-sum government payments or checks, and the income effect was higher, particularly among lower-income households. So it is reasonable to assume that excess savings in Europe are mainly accumulated by high-income households while they are more evenly distributed – and thus more easily spent – in the US.
As a result, European households will likely channel only about one-third of their pandemic savings into consumption. This will give the recovery a welcome moderate boost, with only a limited and temporary impact on prices. An unconstrained consumption boom, on the other hand, could easily turn into something altogether uglier, causing macroeconomic imbalances and higher prices that might prove longer-lasting and even trigger a wage-price spiral.
But even outright bad outcomes are conceivable. For starters, we cannot rule out the so-called “housing option,” whereby the richest European households turn their excess savings into real assets. These savers tend to be more financially savvy than most and more able to invest in illiquid assets. With the rapid spread of new hybrid work arrangements already fueling rising demand for housing, there is a clear danger that these funds will drive house prices to even frothier levels. The mainly negative consequences of this would include cemented inequality – as a large part of the population is simply barred from entering the housing market – and heightened financial risks.
The same could be said about the “equity-market option,” whereby households turn bank deposits into stock investments. A rush into the markets now could have a destabilizing effect, especially if many retail investors were to use their funds for speculative trades, as in the US.
Fortunately, there is a good solution. Using household savings to help accelerate the European economy’s modernization and decarbonization would benefit savers, financial markets, and European Union member states alike. Channeling excess cash into this type of long-term investment would yield a double dividend. Households could earn decent returns, bolstering their nest eggs for old age, and Europe could increase its economic growth potential, creating more opportunities and jobs for all.
But this happy outcome will not materialize by itself. Without the right incentives, the bulk of excess savings might continue to lie idle in bank accounts or find their way into less beneficial investments with environmentally or otherwise undesirable consequences. Policymakers should thus set the right course to unleash these cash piles’ potentially positive effects.
One particularly intriguing option would be to breathe fresh life into the idea of European long-term investment funds (ELTIFs) as part of the European Commission’s action plan to strengthen and complete Europe’s capital markets union. ELTIFs have been around for years, but so far have existed mostly in the shadows and largely failed to appeal to retail investors.
This should change. After all, the idea behind ELTIFs is compelling: they are a vehicle for investing safely in illiquid assets, from start-ups to infrastructure projects. Making them attractive financial products for retail investors requires four main things: more flexible investment guidelines, more adaptable redemption rules, lower required minimum investments, and, above all, favorable tax regimes.
In addition, governments could provide direct subsidies of, say, €20 for every €100 invested, up to a certain limit. Such an initiative would be easily understood and should prove popular. The funds for this could come directly from the €750 billion Next Generation EU program – an elegant way to leverage that instrument’s effectiveness.
Channeling excess private savings into long-term investments that support Europe’s green and digital transformation is vital to inclusive and sustainable growth. Policymakers should capitalize on the one windfall opportunity that the pandemic crisis has brought us.
Ludovic Subran is Chief Economist at Allianz.