Necessary but Insufficient: Addressing Disparities in Inflation-Driven Financial Adversity Requires Advancing Policies that Build Savings

This is the second blog in the ‘Savings and the Economy’ series which provides data-driven insights on the implications of economic instability for household savings and discusses policies that strengthen financial wellbeing.

Inflation remains a significant concern for Americans in the new year. Despite a 30% drop in the inflation rate, from a three-decade high of 9.1% to 6.4% between July and December 2022, the fallout of price inflation on household financial wellbeing continues to vary considerably based on household income, race, gender, and age. While declining inflation bodes well for the broader economy, the precipitous drop in household savings points to a worrying trend.

Americans dealing with the impact of inflation have increasingly turned to credit cards, with balances rising at their highest rate in two decades in the final quarter of 2022. At the same time, the national savings rate plummeted in December to a near all-time low. Both of these trends highlight Americans’ difficulties in responding to unexpected financial challenges and stress the need for greater uptake in emergency savings accounts. This blog will examine these trends and recent legislation that reduces obstacles for creating workplace savings programs.

Coping with Inflation-Driven Financial Adversity

The national savings rate dropped to 2.4% in December 2022, a near all-time low since 1960, reflecting a rise in financial adversity and increasing households’ risk of not being able to handle financial adversity. Recent data shows that American families adopted a range of approaches to cope with rising inflation including putting more on their credit cards, utilizing  accumulated savings, and turning to friends and family. Figure 1 shows trends for three  common measures used to cope with inflation – taking loans or using credit cards to pay for regular expenses, using savings accumulated in retirement and non-retirement accounts, and borrowing from friends and family. Credit card balances , for instance, rose by over 15% in the last quarter of 2022, the largest one quarter increase in these balances over the past twenty years. A fifth of all families had either taken out a bank loan or were using credit cards to pay household expenses by December.

Even as household debt grew, families relied on both accumulated savings and friends and family to tide over financial hardship. The savings utilization rate – the rate at which households draw down on savings accumulated during prosperous times – nearly doubled  over the past year as inflation has risen. The net effect of higher debt and lower savings means that families are less prepared to manage financial emergencies and more exposed to financial adversity, particularly in the case of older adults who live on fixed incomes, low- and moderate-income households, and Black and Hispanic households.

Disparities in Inflation-Driven Financial Adversity

Age is an important factor that affects the ability to cope with economic uncertainty.  Older adults living on fixed income will find it harder to manage household expenses when prices increase but income remains unchanged. Figure 2 shows coping approaches adopted by people ages 65 and up. Households in this age group were more likely than other groups to tap into existing savings while adults ages 55 to 65 and working age families (ages 25 to 55) had higher dependence on credit cards and bank loans to manage household expenses. The higher rate at which older adults have had to dip into accumulated savings will aggravate financial challenges if inflationary pressures persist

High inflation has been particularly damaging to the financial wellbeing of low-income households. Figure 3 shows differences between low- and high-income households’ responses to inflation-driven financial adversity. Over past two years, low-income households (those with less than $25,000 in annual income) were 42% more likely to incur debt through credit card or bank loans and 60% more likely to draw down on savings in retirement and non-retirement accounts compared to high income households (those with annual income of $150,000 to $200,000). Unlike low-income households that have had to rely more on alternate sources of funds like loans, savings, and friends, high-income households have managed household expenses largely from regular income earnings.

Similar patterns of disparities are observed across gender and race. For example, 17% of women and 9% of men depended on credit cards and bank loans to manage household expenses. Higher reliance on credit cards and loans among women indicates increased financial adversity among this group. Not only do women have higher debt as a result of high inflation but women have also drawn down on their savings at the same rate as men. This increases their exposure to non-inflationary sources of financial emergencies such an unexpected job loss, urgent home repairs, or a car breakdown.

Over the past year, Black families witnessed a 26% increase, and Hispanic families saw a 29% increase, in credit card debt and bank loans to manage high household expenses, driven by inflationary factors. White families were more likely to rely on savings and more likely than other groups to borrow from friends and family when faced with financial adversity.  Meanwhile, 39% of Black and 30% of Hispanic households used retirement savings or sold assets to cope with financial adversity, and around 19% of Black and Hispanic households also borrowed from family and friends in times of need. Asian families had lower utilization of credit card debt (14%) and were 32% more reliant on savings in managing inflation. These distinct patterns of coping with financial adversity reveal that Black and Hispanic families have incurred higher levels of debt and have lower savings, which dampens the ability of these households to respond to unexpected future financial challenges.

Policy Solutions: Workplace Policies that Build Household Savings

Policies that help families build savings are fundamental to strengthen financial security and cope with financial adversity such as inflation-driven financial challenges. Secure 2.0, enacted under the 2022 Omnibus Spending Bill, makes important progress in this direction. The law expands access to workplace retirement and emergency savings programs. Under the new legislation, employers that provide employees a means to save for retirement through a 401(k) or 403(b) now have the option of offering and auto-enrolling employees in retirement-linked emergency savings plans funded through payroll deductions. These types of emergency savings plans are important vehicles that help build short-term savings while at the same time helping employees save for their retirement. Most importantly, emergency savings programs have time and again been shown to offset the need for employees facing financial adversity to engage in more expensive capital raising methods such as tapping into retirement assets or incurring high-interest credit card debt.

Secure 2.0 also makes progress on expanding access to retirement savings programs for employees of small- and mid-sized businesses, substantively reduces costs of program administration and provides tax benefits for employers that match employee contributions. These positive steps are necessary but not sufficient to meet disparities in retirement savings and financial preparedness. Advancing policies that prioritize workplace savings are vital to combat inflation-driven financial adversity in an increasingly uncertain economic environment.