Private savings skyrocketed in all major advanced economies during the pandemic, with government furlough schemes filling people’s pockets at a time when lockdowns curbed their opportunities to spend.

Excess savings – the accumulated savings above pre-pandemic trends – amounted to about 10% of gross domestic product (GDP) and 15% of disposable income in the US, and to about 6% – 7% of GDP and 10% of disposable income in the eurozone and the UK. 

Some of these savings are bound to flow back into the economy as reopening leads to renewed growth in consumption and investment.

In a recent Bank of England survey, 27% of respondents said they planned to spend their savings on consumer goods and services, with 10% planning to spend on home improvements. There have been similar findings in the US and Europe.

How much will be spent – and how fast – is difficult to predict, although a 20% reduction of excess savings over a period of two to three years seems to be a realistic scenario across the G3 regions (UK, US, and eurozone).

In addition to a normalisation of the propensity to spend, this should provide an extra boost to consumption of between 6 – 8 percentage points between now and the end of 2023, according to our estimates.

All of this reduces the likelihood of the economy being faced with a ‘fiscal cliff’ – the withdrawal of fiscal support at a time when economies haven’t fully recovered. There are fears that a fiscal cliff could cause an abrupt slowdown in growth from 2022 onwards, but we believe these are exaggerated.

The build-up of savings during the pandemic in part reflects previous fiscal stimulus measures, and the normalisation that we expect in the coming years should be seen as the delayed deployment of part of the pandemic fiscal stimulus.

So that fiscal boost will, in reality, continue to be felt for many years to come.

But the downside is that increased spending could also lead to more inflationary pressures building up, especially at a time of supply-side constraints.

Throughout the pandemic, the Bank of England’s (BoE) approach has been clear. Shaped by the experience of the global financial crisis, the Monetary Policy Committee opted to “go big and go fast”, in the words of Governor Andrew Bailey: slashing the bank rate to 0.10%, doubling quantitative easing (QE) purchases to £895bn, and reviving lending support mechanisms (including substantial loan guarantees).

Yet, as the UK economy continues its recovery, the Bank’s proclivity for accommodative policy has waned. The trigger for this shift is inflation overshooting. But while its near-term signalling is unambiguously hawkish, its underlying reaction function remains much more uncertain.

The problem is that this shift has not been accompanied by more clarity about how far it is prepared to go. This increases uncertainty about its medium-term policy and also raises the risk of either a policy error or a materially weaker domestic economy.