A Model of the Consumption Response to Fiscal Stimulus Payments

Abstract

A wide body of empirical evidence finds that approximately 25 percent of fiscal stimulus payments (e.g., tax rebates) are spent on nondurable household consumption in the quarter that they are received. To interpret this fact, we develop a structural economic model where households can hold two assets: a low-return liquid asset (e.g., cash, checking account) and a high-return illiquid asset that carries a transaction cost (e.g., housing, retirement account). The optimal life-cycle pattern of portfolio choice implies that many households in the model are "wealthy hand-to-mouth": they hold little or no liquid wealth despite owning sizable quantities of illiquid assets. Therefore, they display large propensities to consume out of additional transitory income, and small propensities to consume out of news about future income. We document the existence of such households in data from the Survey of Consumer Finances. A version of the model parameterized to the 2001 tax rebate episode yields consumption responses to fiscal stimulus payments that are in line with the evidence, and an order of magnitude larger than in the standard "one-asset" framework. The model's nonlinearities with respect to the rebate size and the prevailing aggregate economic conditions have implications for policy design.

A Model of Expenditure Shocks

“…Much of the recent theoretical work on MPCs has focused on rationalizing the existence of high-MPC households. For example, Kaplan and Violante (2014) and Carroll et al (2017) show that calibrated models with liquidity constraints and preferences exhibiting prudence can yield households with reasonably high MPCs through (i) precautionary savings, which generate a steep consumption function for lower wealth individuals, and (ii) binding liquidity constraints, which render some households "hand-to-mouth. "…”

“…In contrast, simple permanent income hypothesis models imply that consumption should be much smoother than income. Two potential remedies are pervasive liquidity constraints (e.g., Kaplan and Violante (2014)) or very persistent income shocks, both of which closely tie consumption to current income (vs. permanent income).…”

“…In our theory, house-5 Our framework shares with standard Bewley models the prediction that average MPCs in response to unanticipated transitory income shocks are low (< 0.2) compared to the empirical evidence. We conjecture that integrating our theory of saving constraints with existing frameworks that deliver higher average MPCs (e.g, Kaplan and Violante (2014), Carroll et al (2017)) will be fruitful for developing a comprehensive understanding of the MPC distribution.…”

Global Trends in Interest Rates

“…This specification levers the cross-sectional information contained in our international data set to generalize a similar model that we estimated in Del Negro et al (2017) on data for the United States. One possible interpretation of the γ trends is that they reflect the growth rate of consumption of households that are hand-to-mouth or liquidity constrained (Campbell and Mankiw, 1989;Kaplan and Violante, 2014) and/or are excluded from international asset markets, as in the limited-participation literature (e.g., Vissing-Jorgensen, 2002).…”

Global Trends in Interest Rates

“…This is likely due to the fact that composition of the corporate bond indexes in terms of credit ratings, liquidity, and maturity is different relative to the U.S. 33 Table A1 in the Appendix provides more details on the posterior distribution of the decline in the world real interest rate and in the factors that drive it. the γ trends is that they reflect the growth rate of consumption of households that are hand-to-mouth or liquidity constrained (Campbell and Mankiw, 1989;Kaplan and Violante, 2014) and/or are excluded from international asset markets, as in the limited-participation literature (e.g., Vissing-Jorgensen, 2002).…”