Savings threatened by inflation

By Céline Gimet, Professor of International Economics and Finance at the Institut d’Etudes Politiques d’Aix-en-Provence.

The question of inflation’s impact on savings falls within the foundational analytical framework established by Irving Fisher. However, recent empirical developments particularly in the wake of the 2021–2023 inflationary shock have renewed and refined our understanding of the mechanisms at play, while revealing an apparent paradox. Even as inflation erodes households’ real savings stock, the aggregate savings rate does not decline and even tends to rise in the euro area. Resolving this paradox requires considering the differentiated effects of inflation, as well as distinguishing between real wealth dynamics and nominal savings flows

The illusion of preserved capital

The erosion of savings can be explained by the gap between nominal and real returns, with the latter serving as the relevant measure of intertemporal purchasing power. In the short term, the adjustment of nominal rates to expected inflation remains incomplete due to rigidities and factors related to the credibility of monetary authorities and financial conditions. Two main mechanisms shape this dynamic. On the one hand, the Mundell-Tobin effect implies that a rise in expected inflation leads to a shift from monetary holdings to real assets, which increases capital accumulation and reduces its marginal return. On the other hand, liquidity premiums reflect agents’ willingness to accept persistently low returns on liquid assets in exchange for their availability. This gap between nominal and real value points to the money illusion. Households continue to perceive their savings as preserved because the stated capital does not decrease, even as its real value erodes. The St. Louis Fed estimated this erosion at approximately $1.8 trillion in U.S. deposits during the 2022 shock; for Germany and Spain, the loss amounted to 5.4% and 10.4% of nominal GDP, respectively, over the same period.

This threat does not affect all forms of savings with the same intensity. Cash holdings and demand deposits are the most vulnerable. They yield no nominal return, or a return that is well below inflation. Nominal fixed-rate bonds suffer a double loss due to the depreciation of market value (rate effect) and the erosion of the real value of coupons and principal. Residential real estate has often been presented as an effective hedge against inflation, including unexpected inflation. However, recent research shows more mixed results in Europe, depending on tax regimes, credit conditions, and national cycles. Equities theoretically offer long-term protection, as companies can adjust their prices. In practice, this ability depends on sectoral market power and macroeconomic conditions, as short-term protection is uncertain. Finally, inflation-indexed products offer high protection against expected inflation, but access to them remains uneven.

A threat that widens inequality

In addition to this heterogeneity across asset classes, there is also price asymmetry. Low-income households are more exposed to energy and food inflation, which reduces their ability to save. The interaction with the tax system through the mechanism of bracket creep exacerbates this effect. In non-indexed systems, nominal income growth can lead to an increase in the effective tax rate without any real gain in purchasing power. This effect increases government revenue and reduces real disposable income, automatically weighing on savings.

More broadly, inflation has varying redistributive effects. Expected inflation is largely factored into nominal interest rates and asset prices and does not lead to a redistribution of wealth. Conversely, unexpected inflation redistributes wealth. It penalizes nominal creditors and benefits fixed-rate debtors. Older households and bondholders are generally more exposed, while indebted households may benefit relatively. The government itself benefits from an erosion of the real value of its debt.

The dynamics do not end with the initial shock. Economic agents base their decisions on perceived inflation, which is consistently higher than measured inflation, particularly during periods of shock. High perceived inflation can encourage immediate consumption (intertemporal substitution effect) or, conversely, lead to increased precautionary saving in response to uncertainty, with the extent of this response varying by income level.

When uncertainty drives people to save what inflation is eating away

It is the interplay of these mechanisms that sheds light on the initial paradox. According to the ECB, households’ real net worth declined in 2022 in the euro area and returned to its pre-pandemic level during 2023, contributing to the rise in the savings rate. This apparent contradiction can be explained by a decoupling between stock and flow. Real savings stock decreases due to inflation, while the savings flow increases due to several combined factors: defensive adjustment by households (precautionary motive), post-health-crisis normalization of consumption behavior, rising nominal incomes, and composition effects related to wealthier households, which have a higher propensity to save.

The threat that inflation poses to savings is thus real but fundamentally varied. These observations raise an open policy question: namely, the protective measures available to all savers and the need to adapt tax systems—an issue that is all the more pressing given that the households most at risk are those with the fewest resources to protect themselves.