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Americans during the pandemic socked away more money than they had at any time since World War II — supercharging inflation once they started spending again. Many policymakers expect that those excess savings will be depleted sooner rather than later, leading to lower inflation. There are that the worst of the price hikes may be over.

But spending that extra stockpile, , could take a lot longer than monetary experts think — meaning that inflation is likely to remain a problem for some time. So says Adrien Auclert, a faculty fellow at the ��ɫApp Institute for Economic Policy Research (SIEPR) and an assistant professor of economics in the School of Humanities and Sciences, in a new working paper. Conventional wisdom about the effects of the extraordinary savings rate on inflation, Auclert and his co-authors write, overlooks an important dynamic: One person’s spending is another person’s income. This means that the money lower-income Americans are now spending to make ends meet will ultimately “trickle up” to the highest-income earners — pressuring prices and worsening wealth inequality. Here, in an interview, Auclert explains what’s happening and why it matters.

What is conventional wisdom missing?

Monetary and fiscal policy affect different groups of people differently, and that sometimes gets overlooked. A few months ago, I spoke with the president of a Federal Reserve Bank who, like many other monetary policymakers and investment bankers, was assuming that the excess savings that Americans accumulated during the pandemic would be gone within six months or a year. That calculation matters for monetary policy because it affects both the outlook for consumer spending – while people spend down their savings, they raise demand for goods and services – and the outlook for inflation, since firms set prices based on expected demand. But when I asked what the estimate was based on, it was clear it came from a model that wasn’t recognizing that, as people spend down their savings, they are creating income for somebody else. So, someone else’s savings is going up, and that someone else is richer because of it.

Can you elaborate on what you mean by “trickling up”?

Most people have heard of trickle-down economics, or Reaganomics. It’s the belief that tax cuts for the rich create jobs for the poor. But fiscal policy during the pandemic targeted the poor by giving them money. It is the opposite of Reaganomics in that, as we show in our paper, the poorest Americans end up spending their savings first. Because the United States is a fairly closed economy — at least $80 of every $100 spent goes to U.S.-produced goods and services — this savings will slowly over time make its way up to the richest Americans. The super-rich will eventually hold most of the excess savings, which will increase wealth inequality.

Policymakers are relying on calculations that ignore this trickling-up effect. When you take it into account, you see that the effect of excess savings on aggregate demand will last quite a bit longer. And so, if we’re worried that the spending down of this savings is inflationary, that means that there is more inflation in the pipeline than some people tend to assume.

How much more?

My co-authors (Matthew Rognlie, an assistant professor of economics at Northwestern, and Ludwig Straub, an assistant professor of economics at Harvard) and I conclude that the effects of excess savings are likely to stick around for somewhere between two and five years — and not, as conventional wisdom holds, for only a few quarters.

What can monetary policymakers do to offset this trickling-up effect?

They could raise interest rates, which would mitigate demand and induce people to save more. This would speed up the trickling-up effect. It’s still a slow process, slower than I think people realize. And it doesn’t prevent the rise in wealth inequality. That’s because the rich spend less of their income than the poor, so they hold onto their savings longer. In fact, in the model we study in this paper, no matter what happens with monetary policy, everyone eventually spends down their savings except for the super-rich.

So, what can be done to offset the growth in wealth inequality?

If you want to undo the inequality effect, you’d need to tax the very wealthy.

Let me explain why. In , my co-authors and I — along with Rishabh Aggarwal, a PhD student at ��ɫApp — found that most of the increase in Americans’ savings during the pandemic was because of government stimulus. Of course, during the pandemic lockdowns, people cut their consumption. But if it hadn’t been for government stimulus, their income would have fallen as well, and they would not have been able to save the way they did.

Now, the government issued lots of bonds to finance the money it transferred to people. Who’s holding those bonds? Initially, those bonds may have been held by lots of folks, indirectly or maybe directly through brokerage accounts. But as people sell those bonds to finance their spending, others — presumably wealthier people — buy them. That’s the trickling-up story that our model tells. In the end, the super-rich hold the government debt.

One way to mitigate the inequality effects we describe would be to reverse the increase in government debt. In other words, the government would need to buy back the bonds, presumably financing that by increasing taxes. It matters who you tax at that point. The U.S. income tax code is somewhat progressive, so raising income taxes would tend to affect the rich more than the poor. But you’d still be hurting the poor, who didn’t benefit from the trickling-up effect in the first place. A capital gains or a wealth tax may be more effective at offsetting the inequality generated by this trickling-up process.

There’s an important caveat to this. Any measure for addressing wealth inequality is incomplete without also addressing wage inequality. Our paper is about the effect that pandemic cash transfers are having on wealth inequality. Addressing wage inequality is equally, if not more, important.