Econometrica: Jul 2014, Volume 82, Issue 4

A Model of the Consumption Response to Fiscal Stimulus Payments

https://doi.org/10.3982/ECTA10528
p. 1199-1239

Greg Kaplan, Giovanni L. Violante

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.

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Supplemental Material

Supplement to "A Model of the Consumption Response to Fiscal Stimulus Payments"

This appendix is organized as follows.  Section A illustrates another case of wealthy hand to mouth behavior which completes the discussion of Section 4.1 in the main text. Section B contains more details on our definitions of liquid and illiquid wealth from the SCF and on the measurement of hand-to-mouth households.  Section C describes certain steps of the model's calibration omitted from the main text.  Section D contains a robustness analysis on the baseline rebate experiment.  The numerical computation of the model and the simulation of the policy experiments are delineated in Section E.

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Supplement to "A Model of the Consumption Response to Fiscal Stimulus Payments"

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