A model of the consumption response to fiscal stimulus payments

Greg Kaplan, Giovanni L. Violante

    Research output: Contribution to journalArticle

    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.

    Original languageEnglish (US)
    Pages (from-to)1199-1239
    Number of pages41
    JournalEconometrica
    Volume82
    Issue number4
    DOIs
    StatePublished - 2014

    Fingerprint

    Assets
    Fiscal stimulus
    Payment
    Rebates
    Household
    Tax
    Income
    Propensity
    News
    Empirical evidence
    Life cycle
    Policy design
    Retirement
    Wealth
    Consumer finance
    Household consumption
    Economic conditions
    Transaction costs
    Portfolio choice
    Cash

    Keywords

    • Consumption
    • Fiscal stimulus payments
    • Hand-to-mouth
    • Liquidity

    ASJC Scopus subject areas

    • Economics and Econometrics

    Cite this

    A model of the consumption response to fiscal stimulus payments. / Kaplan, Greg; Violante, Giovanni L.

    In: Econometrica, Vol. 82, No. 4, 2014, p. 1199-1239.

    Research output: Contribution to journalArticle

    Kaplan, Greg ; Violante, Giovanni L. / A model of the consumption response to fiscal stimulus payments. In: Econometrica. 2014 ; Vol. 82, No. 4. pp. 1199-1239.
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