Understanding the Consumption Response to Fiscal Stimulus Payments: A Structural Analysis
Fiscal stimulus payments (e.g., tax rebates and other forms of cash transfers to families) are a very common policy instrument used by governments in the US and other countries to stabilize aggregate economic activity and moderate the effects of recessions on household welfare. Fiscal interventions of this type have been authorized by Congress during the economic downturns of 1975, 2001, 2008, and 2009. Families have received payments of between $300 and $1,000, depending on the specific episode and on household size. In the aggregate, these fiscal outlays have been remarkably large: around $38B in 2001, $79B in 2008, and $60B in 2009. There already exists a wide body of empirical evidence, based on the spending patterns of a sample of US households around the time of these policy episodes, which examines how household expenditures are affected by fiscal stimulus payments. This collective body of empirical evidence concludes that nondurable household consumption (i.e., spending on food, utilities, personal services, transportation, gas, etc...) rises by around 30 percent in the quarter in which stimulus payments are received, and that this estimate almost doubles when durable goods (e.g., small household durables and cars) are included. These findings are somewhat puzzling since existing economic theories predict that households will only spend a much smaller fraction of the payment, and will either save the majority (or use it to pay down debt). The goal of the proposed research is to develop an economic model that both provides a coherent explanation for the large observed response of household consumption expenditures to fiscal stimulus payments, and can be used to predict the spending patterns of households in response to future episodes of stimulus payments under different macroeconomic conditions. The proposed research relies on the central insight that households spend a substantial part of their payments because a large fraction of households are liquidity constrained. In particular, survey evidence on household portfolios suggests that even households who own substantial wealth in the form of cars, home equity, or retirement accounts can be constrained because such assets are illiquid, i.e., it is costly to convert these assets into the cash needed to sustain consumption expenditures in a recession. For this reason, a significant fraction of fiscal stimulus payments -which are instead liquid- is spent very rapidly. As learned painfully from the last downturn, recessions are not all alike. This means that despite the existing empirical evidence, one cannot assume that future stimulus payments of different amounts in different economic conditions will have the same effects on spending. The propsed economic model will be useful to evaluate what the aggregate effects of fiscal stimulus payments would be under different macroeconomic and liquidity conditions. The model will also provide a framework for running 'counterfactual' policy experiments in order to gauge the benefits of fiscal stimulus payments relative to alternative fiscal policy options that are also aimed at providing temporary relief to US households during economic recessions. This is important because the money that is spent on fiscal stimulus payments could arguably be spent on other policies that may also increase household expenditure, such as, increasing the generosity of unemployment benefits, or reducing indirect taxes on consumption spending.
It is often assumed that fiscal stimulus works mostly by spurring spending among the poorest households who need the extra cash the most (the "poor-hand-to-mouth"). In this research, we show that another group of households – the "wealthy-hand-to-mouth" – also consume all of their disposable income every period. In our research, we find that both the wealthy hand-to-mouth (those with little or no liquid wealth but substantial holdings of illiquid assets – those that carry a transaction cost to access, such as housing, large durables, or retirement accounts, as opposed to liquid cash, checking, and saving accounts), and the "poor-hand-to-mouth" behave similarly: both groups have "large marginal propensities to consume out of small income changes – a key determinant of the macroeconomic effects of fiscal policy," they write. The wealthy-hand-to-mouth choose to weather income fluctuations rather than dipping into their assets to smooth shocks , because smoothing shocks would entail holding large balances of cash and foregoing the high return on their illiquid assets. We document that around one-third of all US households live hand-to-mouth (around 38 million households in 2010, based on 117 million households in 2010, Census Bureau), and of that group, over two-thirds are indeed wealthy-hand-to-mouth. While poor-hand-to-mouth households are most frequently young with low incomes, the wealthy-hand-to-mouth are older (peaking around age 40), have high incomes (similar to the non-hand-to-mouth) and hold substantial illiquid assets (at age 40, around $50,000 on average). In addition, wealthy-hand-to-mouth households hold portfolios that are very similar to the non-hand-to-mouth in terms of their shares of illiquid wealth held in housing and retirement accounts. Unlike the poor hand-to-mouth who tend to stay in this state for long periods of time, wealthy-hand-to-mouth status is transient, lasting an average of only 2.5 years. We also compare households in the US to Canada, Australia, the UK, Germany, France, Italy, and Spain to document the share of the wealthy-hand-to-mouth households across countries, their demographic characteristics, the composition of their balance sheets, and how long families remain hand-to-mouth. The findings are important for policymakers, given the question of which demographic groups to target in order to obtain the biggest bang-for-the-buck from fiscal stimulus programs designed during economic recessions. The findings suggest that, not just the poor households, but also middle-class households with large mortgages may have high spending rate with respect to government transfers. However, our results also imply that increasing the size of the rebate too much can lead to lower spending rates, as wealthy hand-to-mouth households start useing the extra cash to reduce their debt instead of consuming.
