November 21, 2021
by Steve Stofka
Two billionaires, Warren Buffett and Elon Musk, pause before the packaged meat in a grocery store. This past week the price of rib eye steak, their favorite, has gone up a lot. Elon has had a busy week and wants a good rib eye so he picks out a steak and puts it in his basket. Warren would also like a rib eye but can’t bring himself to spend that much on a meal he will cook at home. He decides to buy the top sirloin and marinate it for a few hours. For whatever reason, Warren has reacted to a rise in the price of one good by substituting another good. Economists call this the substitution effect.
The next day Mary is shopping at that same store for a top sirloin steak for dinner. She notices that a few rib eye steaks are on sale for half-price. The expiration date is the next day but she intends to cook it that night so that is not a concern. Just as Warren did the previous day, Mary has responded to a price change by substituting one good for another. What about Elon? His response was to pay the higher price, substituting a different good, his income, for the higher price. Economists call this the income effect, where we substitute money for the higher price. Where does the money come from?
One source is savings, our backup income stream. Savings is the amount of income we have left over after paying taxes and buying stuff. It’s the money we didn’t spend before. After age 40, we become more conscious of the need to save for the later years in life when we stop working. Here’s a chart of per person savings for those over the age of 55. This does not include the equity that people have built up in their homes or investment accounts, but it does show broad trends.
The first of the Boomer generation turned 55 in 2001, a tumultuous year marked by the 9-11 attack, the dot-com bust and the buildup to the Iraq war. During the 2000s, economists and financial advisors warned that the Boomers had not saved enough. The Boomers complained that higher payroll taxes (Tax Policy Center, 2019), used to support earlier generations who had not paid in enough to Social Security, had reduced their ability to save. When the financial crisis reduced the value of both homes and investments, Boomers realized that their savings were too low. During the following decade, many worked past retirement age. Cautious spending by this age group restrained economic growth following the crisis and kept inflation in check during the recovery.
In the spring of 2020, Covid hospitalizations and death shot up in New York City and other urban hotspots. The Trump administration shut down most of the economy for several weeks. Congress and the administration passed emergency measures to provide relief to people who had lost their jobs. Savings shot up and incomes dropped. The pattern for all adults was the same as for older Americans.
As stores reopened and the economy recovered, it was inevitable that some of those savings would be drained away to buy stuff. The abrupt decline in savings has put pressure on prices. Are inflationary pressures temporary or more permanent? Older generations have built up a reserve buying power that they did not have at the onset of the financial crisis twelve years ago.
There are 70 million Boomers who are spending down their accumulated savings. The Millennial generation, now 72 million strong, is the counterbalancing force to that dis-savings. Older Millennials are crossing the age-40 threshold when people start thinking that they had better put something away for the future. This tug of war in spending and savings between these two generations could continue to put upward pressure on prices for several more years.
Photo by Damir Spanic on Unsplash
Tax Policy Center. (2019, July 18). Payroll tax rates. Retrieved November 20, 2021, from https://www.taxpolicycenter.org/statistics/payroll-tax-rates. From 1970 to 1990, payroll tax rates increased by 50%.