Savings rates among European households have reached record levels during the Corona recession (see Figure 1). Simultaneously, the average debt to GDP ratio of the euro area is expected to increase by 15% through 2020,¹ although the degree to which this is driven by increased spending, as opposed to decreased tax receipts, varies substantially by country. The sharp rise in household savings rates appears high enough to completely offset the increase in government deficit spending at the aggregate, while firm savings rates remain largely unchanged, such that countries’ economy wide savings rates (private and public) are roughly unchanged relative to their pre-COVID-19 levels.

Understanding why households are saving so much is crucial for understanding how and when we should expect aggregate demand to return to pre-COVID-19 levels. In this note, we propose three explanations for the sharp rise in savings and assess their ability to explain variation in household savings across European countries.

Perhaps the most obvious explanation for the increase in savings is reduced consumption opportunities related to lockdown measures. By shutting down restaurants, discouraging travel, and limiting retail capacity, governments reduced consumers’ opportunities to spend. While consumers may substitute these lost consumption opportunities with online spending, many may prefer to bide their time until they can travel or eat out again. This explanation can be thought as the supply hypothesis as, under this explanation, the decline in household consumption is not driven by demand. If households were unable to spend, a relaxation of measures may then result in a strong, perhaps short-lived consumption boom in the spring/summer of 2021. Especially those sectors that particularly suffered during the lockdown (tourism, restaurants, retail stores) would benefit.

Another intuitive explanation is that the increase in savings is driven by a decline in household demand. Fears of future employment income losses associated with increased economic uncertainty may have driven households to accumulate precautionary savings. It is well established in the theoretical and empirical literature that economic uncertainty associated with recessions drives households to reduce consumption.² This explanation would tie a recovery in consumption to the economic recovery: To the extent that economic uncertainty persists even after lockdown measures have been phased out and adjustments to economic preferences due to Corona imply substantial structural adjustments, we would expect the recovery in consumption to be weak in 2021.

The third explanation is related to the sharp increase in deficit spending associated with the fiscal response packages to the recession. As households are forward looking, debt-financed increases in government spending may induce households to save in anticipation of future tax hikes to pay off the government’s debt. In the academic literature, this is known as Ricardian Equivalence.³ If households are worried about future tax payments, the increase in savings will persist until governments substantially reduce their deficits and debt levels. Hence, the recovery in consumption in 2021 can be expected to be weak based on this explanation as well.

In the cross-sectional data, we observe a relationship that appears to be consistent with Ricardian Equivalence (see Figures 1 and 2). In other words, countries where the government is running a higher deficit also happen to be countries where households are saving more.