The role of pent-up demand in the euro area recovery in 2021

The lockdowns and other measures imposed to contain the spread of COVID-19 have led to a marked increase in the savings of European households. The closure of non-essential businesses and many leisure activities, together with restrictions on mobility and activity and increased uncertainty, have caused the savings rate in the euro area to rise, peaking at around 25% during Q2 2020 in contrast to the 13% prior to the pandemic.

This level of saving that has been «forced» by the COVID-19 crisis is substantial and, therefore, has the potential to spur the economic recovery when the control of the pandemic allows for a more sustained revival of economic activity. Will European households spend these forced savings when the restrictions are lifted? At what speed? How will this impact economic growth?

The current situation has no modern precedent, as the income declines that accompany recessions usually take a heavy toll on savings. However, there are some examples of forced savings in history. In the US, rationing and supply restrictions during World War II led to a huge increase in American households’ savings, of around 40% of GDP according to some estimates. After the war, American households quickly reduced their savings rates, providing an additional boost to the economic revival.1

Bridging the historical distance, in the current case of Europe, the amount of savings accumulated during the pandemic is also significant: slightly over 4% of pre-pandemic GDP in 2020 as a whole. The extent to which these savings could spur the recovery will depend on the factors which caused the drop in consumption and the rise in savings in the first place: the restrictions on consumption themselves, uncertainty surrounding the economic outlook and changes in household incomes. Using a simple model,2 we identified the contribution of these three forces to the change in household consumption during 2020 as a whole.3^,4 According to these estimates, the bulk of the loss of consumption in 2020 was due to the restrictions, as shown in the first chart, although the increase in uncertainty also made a significant contribution to the fall in consumption. In contrast, the change in gross disposable income slowed some of the decline in consumption, as household income did not recede in 2020 as it would in traditional recessions, but rather was sustained by the fiscal support from European countries.5

These contributions suggest that, when the control of the pandemic allows the restrictions to be lifted, much of the pent-up savings could be undone. To obtain more clues about how fast and to what extent these savings could boost the recovery, we will leverage the historical relationships from our consumption model to assess the impact in 2021 of the three major drivers we have just identified. In particular, we consider a scenario in which the immunisation of the risk groups triggers an easing of the restrictions and a more sustained economic recovery beginning in Q2 2021, with a relatively rapid reduction in uncertainty and a gradual growth in household incomes.6 In this scenario, our model’s prediction (see the grey line in the second chart) suggests a strong rebound in household spending over the coming quarters.

However, this projection is somewhat optimistic, since it assumes that the consumption which was lost in 2020 as a result of the uncertainty and restrictions will be recovered in 2021 to the same extent.7 In other words, it assumes that up to two-thirds of the pent-up demand of 2020 will be undone and will materialise in 2021.8 However, in practice, there are several factors that will alter this rebound in consumption.

Firstly, a significant portion of the savings accumulated in 2020 comes from a variety of services that cannot be deferred in time. For instance, when the restrictions are eased and we can go to see our favourite bands in concert, we will probably begin by going to more concerts than we used to in pre-pandemic times, but it is hard to image that this initial push will compensate for all the concerts we missed during 2020. In other words, pent-up demand is undone more slowly when the consumption previously sacrificed has been that of services.

Secondly, much of the savings accumulated in 2020 are concentrated among people with higher incomes,9 and it is precisely those groups that have a lower marginal propensity to consume. Therefore, when the restrictions are eased and we begin to recover our pre-pandemic consumption habits, the households with the greatest purchasing power could also be those who spend their pent-up savings the least in relative terms. Also, the experience of countries such as the US shows that many households have used some of the savings they have accumulated in 2020 to reduce their debts rather than to consume.10

Thirdly, the pandemic is likely to dent expectations. On the one hand, recessions usually make households more risk-averse,11 so precautionary factors continue to weigh on consumption even if uncertainty subsides. On the other hand, faced with the sharp rise in public debt driven by the support measures adopted during this crisis, there is a possibility that households may retain some of their accumulated savings as a precautionary measure to help them address potential future tax hikes.12

All these elements suggest that the reduction in uncertainty and the easing of restrictions will have a less pronounced effect on consumption. When we incorporate this less pronounced effect into our model,13 we obtain a more moderate projection of consumption in 202114 (see the blue line in the second chart): one-third of the savings accumulated in 2020 would be undone.

All in all, pent-up demand is likely to help spur the recovery, and while it may not be fully undone, it will have a significant impact on economic activity as a whole (see third chart). Indeed, our estimates suggest that, in the optimistic scenario, the unwinding of pent-up savings could add 2.5 pps to euro area GDP in 2021, or slightly more than 1 pp in the more moderate scenario (in both cases relative to a scenario in which none of the pent-up demand is undone).15