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Monday, February 08, 2016

'Wealthy ‘Hand-to-Mouth’ Households: Key to Understanding the Impacts of Fiscal Stimulus'


Greg Kaplan and Giovanni Violante at Microeconomic Insights:

Wealthy ‘hand-to-mouth’ households: key to understanding the impacts of fiscal stimulus: Many families in Europe and North America have substantial assets in the form of housing and retirement accounts but little in the way of liquid wealth or credit facilities to offset short-term income falls. This research shows that these wealthy ‘hand-to-mouth’ households respond strongly to receiving temporary government transfers such as tax rebates, boosting the economy through their increased consumption. ...
Our research also draws attention to the fact that the aggregate macroeconomic conditions surrounding policy interventions will affect the fraction of the transfer consumed by households in non-trivial ways.
In a mild recession, where earnings drops are small and short-lived, it is not worthwhile for the wealthy hand-to-mouth households to pay the transaction costs of accessing some of their illiquid assets (or to use expensive credit) to smooth their consumption. As a result, liquidity constraints get amplified and their consumption response to the receipt of a fiscal stimulus payment is strong.
Counter-intuitively, the same stimulus policy may have stronger effects in a mild downturn than in a severe recession
Conversely, at the outset of a severe recession that induces a large and long-lasting fall in income, many wealthy hand-to-mouth households will choose to borrow or tap into their illiquid account to create a buffer of liquid assets that can be used to counteract the income loss. Consequently, fewer households are hand-to-mouth when they receive a government windfall. Thus, somewhat counter-intuitively, the effect of the stimulus on consumption can be lower than when the same policy is implemented in a mild downturn.
Acknowledging the existence of wealthy hand-to-mouth households also has implications for economic policy beyond fiscal stimulus. In further work (Kaplan et al, 2015), we show the importance of these households for the efficacy of both conventional monetary policy (changes in nominal interest rates) and unconventional monetary policy (forward guidance about future changes in nominal interest rates).

    Posted by on Monday, February 8, 2016 at 10:11 AM in Economics, Fiscal Policy | Permalink  Comments (15)


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