One of the most under-reported stories of the pandemic is the massive amount of money piling up in the nation’s banking system. That money will come back into the economy at some point, with the possibility of major economic stimulus, but also the real danger of inflation.
The money is piling up for the simple reason that incomes are up and spending is down. Yes, incomes are up, even though economic activity has slowed. The money injected into the economy by the federal government, through expanded unemployment benefits and the $1,200 “economic impact” payments, has more than made up for the decline in regular incomes. Figure 1 shows the basic blocks of personal income for the past several months.
Wages began to drop in March, but since most layoffs were in the second half of the month, and many unemployment insurance systems experienced delays, the March UI payments were not much larger than February’s. Then in April, while wages fell, UI payments started to roll in, and the massive infusion of dollars through the economic impact payments hit. This caused a large jump in total personal income for the month of April. By May, UI was expanding, with additional federal payments, and impact payments had slowed to a trickle. But wages and proprietors’ income were beginning to recover, so personal income in May (reported on June 26) was still higher than in February.
Figure 2 shows the rates of growth of the components of personal income between February and May, with the investment category broken out.
As the bars and lines in Figure 1 make clear as well, most categories of income fell, but UI grew massively. Personal income was higher in May than February, even without the impact payments. (Personal income figures from the Bureau of Economic Analysis count Medicare and Medicaid benefits as income, but Figures 1 and 2 do not include them.)
Now, to the question of the piling up of money. Figure 3 shows what households did with their after-tax disposable personal income in the past four months.
The short answer: they saved a lot of it. The pattern of spending in this recession is quite different from that in the past. Generally, in a downturn, households cut back drastically on durable goods: the aging car or refrigerator can last another six months. But while durable goods spending dipped in April, it is now just about back to February levels. Non-durable goods spending grew in March (all that toilet paper), dropped in April, and by May was almost back to February levels.
The big hit was in services, which were either closed down (restaurants, dentists) or just too scary (plane rides). Services spending grew by 6 percent from April to May but remains 15 percent below February levels.
So, with incomes up due to government payments and some recovery, and spending persistently down, household savings rates have shot up. With spending already cut in March, money started to build up. By April, spending was way down, and the savings rate went up to an astonishing 32 percent. By May, the savings rate was still sitting at a very high 23 percent. Typical savings rates are around 7 percent.
We can see where all that cash sits by looking at the money supply figures published by the Federal Reserve. The cash that is available to households and businesses to spend is categorized as either M-1, the most readily available (currency and checking accounts) and M-2 (M-1 plus savings accounts that can be tapped easily). Figure 4 shows the M-1 and M-2 money supply going back into 2019. The blue areas are M-1 and the green areas are the parts of M-2 that are not in M-1.
We see the money supply skimming along smoothly through 2019 and into 2020, just topping $15 trillion and growing an average of 0.15 percent per week. Then, beginning the week of March 2, the money supply started to climb an average of over 1 percent per week. The total M-2 is now $2.8 trillion, or 18 percent higher than in mid-February. $2.8 trillion amounts to $8,500 for every person in the country.
To show how dramatic this money supply growth is, Figure 5 show the M-2 money supply from 1980 to the present, with a shaded area indicating the Great Recession of 2007-2009.
The sharp upturn at the far right of the graph is the past three months. Nowhere in the past 40 years has the money supply seen anywhere near that kind of short term growth.
Contemporary macroeconomic theory pays close attention to the money supply, as it is a major determinant of both economic growth and inflation. The unprecedented growth in the money supply offers both hope and fear. The hope is that once the households that have remained economically secure can start spending again, they will tap into all that money and fire up the economy. The recent money supply growth amounts to about 13 percent of GDP and can make a huge difference if unleashed. The relative strength of durable goods purchasing, and the larger sums of money in bank accounts, indicate that perhaps households will spend those dollars on cars, appliances, home improvements and other big ticket items that provide strong economic stimulus.
The fear is inflation. The economy has been damaged, and industries may not be able to gear up in time for a consumer onrush, resulting in shortages and higher prices. The Fed will have its hands full as it tries to get the economy back up to the right temperature: high enough to get unemployment down to normal levels, but not so hot as to fuel excessive inflation.