A wide body of empirical evidence, based on randomized experiments, finds that 20-40 percent of fiscal stimulus payments (e.g. tax rebates) are spent on non-durable household consumption in the quarter that they are received. We develop a structural economic model to interpret this evidence. Our model integrates the classical Baumol-Tobin model of money demand into the workhorse incomplete-markets life-cycle economy. In this framework, households can hold two assets: a low-return liquid asset (e.g., cash, checking account) and a high-return illiquid asset (e.g., housing, retirement account) that carries a transaction cost. The optimal life-cycle pattern of wealth accumulation implies that many households are "wealthy hand-to-mouth": they hold little or no liquid wealth despite owning sizable quantities of illiquid assets. They therefore display large propensities to consume out of additional income. We document the existence of such households in data from the Survey of Consumer Finances. A version of the model parametrized to the 2001 tax rebate episode is able to generate consumption responses to fiscal stimulus payments that are in line with the data.

A Model of the Consumption Response to Fiscal Stimulus Payments

A wide body of empirical evidence, based on randomized experiments, finds that 20-40 percent of fiscal stimulus payments (e.g. tax rebates) are spent on nondurable household consumption in the quarter that they are received. We develop a structural economic model to interpret this evidence. Our model integrates the classical Baumol-Tobin model of money demand into the workhorse incomplete-markets life-cycle economy. In this framework, households can hold two assets: a low-return liquid asset (e.g., cash, checking account) and a high-return illiquid asset (e.g., housing, retirement account) that carries a transaction cost. The optimal life-cycle pattern of wealth accumulation implies that many households are “wealthy hand-to-mouth”: they hold little or no liquid wealth despite owning sizeable quantities of illiquid assets. They therefore display large propensities to consume out of additional 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 is able to generate consumption responses to fiscal stimulus payments that are in line with the data.

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The wealthy hand-to-mouth are households who hold little or no liquid wealth (cash, checking, and savings accounts), despite owning sizable amounts of illiquid assets (assets that carry a transaction cost, such as housing or retirement accounts). We use survey data on household portfolios for the U.S., Canada, Australia, the U.K., Germany, France, Italy, and Spain to document the share of such households across countries, their demographic characteristics, the composition of their balance sheets, and the persistence of hand-to-mouth status over the life cycle. The portfolio configuration of the wealthy hand-to-mouth suggests that these households may have a high marginal propensity to consume out of transitory income changes, a prediction for which we find empirical support in PSID data. We explain the implications of this group of consumers for macroeconomic modeling and fiscal policy analysis.

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The wealthy hand-to-mouth

Most countries have automatic rules in their tax-and-transfer systems that are partly intended to stabilize economic uctuations. This paper measures how eective they are at lowering the volatility of U.S. economic activity. We identify seven potential stabilizers in the data and include four theoretical channels through which they may operate in a business cycle model calibrated to the U.S. data. The model is used to compare the volatility of output in the data with counterfactuals where some, or all, of the stabilizers are shut down. Our rst nding is that proportional taxes, like sales, property and corporate income taxes, contribute little to stabilization. Our second

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The role of automatic stabilizers in the U.S. business cycle

We do not have a good measure of the effects of fiscal policy in a recession because the methods that we use to estimate the effects of fiscal policy—both those using the observed outcomes following different policies in aggregate data and those studying counterfactuals in fitted model economies—almost entirely ignore the state of the economy and estimate "the" government multiplier, which is presumably a weighted average of the one we care about—the multiplier in a recession—and one we care less about—the multiplier in an expansion. Notable exceptions to this general claim sug gest this difference is potentially large. Our lack of knowledge stems significantly from the focus on linear dynamics: vector autoregressions and linearized (or close-to-linear) dynamic stochastic general equilibrium (DSGE) models. Our lack of knowledge also reflects a lack of data: deep recessions are few and nonlinearities hard to measure. The lack of statistical power in the estimation of nonlinear models using aggregate data can be addressed by exploiting estimates of partial-equilibrium responses in disaggregated data. Microeconomic estimates of the partial-equilibrium causal effects of a policy can discipline the causal channels inherent in any DSGE model of the general equilibrium effects of policy. Microeconomic studies can also provide measures of the dependence of the effects of a policy on the states of different agents, which is a key component of the dependence of the general-equilibrium effects of fiscal policy on the state of the

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On Measuring the Effects of Fiscal Policy in Recessions

We build a life-cycle model with earnings risk, liquidity constraints, and portfolio choice over tax-deferred and taxable assets to evaluate how household consumption changes in response to shocks to transitory anticipated income, such as the 2001 income tax rebate. Households optimally invest in tax-deferred assets, which are encumbered by withdrawal penalties, and exchange taxable precautionary savings for higher after-tax returns. The model predicts a higher marginal propensity to consume out of a rebate than is predicted by a standard frictionless life-cycle model. Liquidity-constrained households—with few financial assets or portfolios expensive to reallocate—consume a higher fraction of the rebates. (JEL D91, E21, G11, H24)

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Jonathan Huntley

Papers

Can Tax Rebates Stimulate Consumption Spending in a Life-Cycle Model?†