A Model of the Consumption Response to Fiscal Stimulus Payments

69 Pages Posted: 29 Aug 2011 Last revised: 8 Sep 2011

See all articles by Greg Kaplan

Greg Kaplan

University of Pennsylvania

Giovanni L. Violante

New York University, Department of Economics; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: August 2011

Abstract

A wide body of empirical evidence finds that around 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 sizeable quantities of illiquid assets. They therefore 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 size of the rebate, its degree of phasing-out, and aggregate economic conditions have implications for policy design.

Suggested Citation

Kaplan, Greg and Violante, Giovanni L., A Model of the Consumption Response to Fiscal Stimulus Payments (August 2011). NBER Working Paper No. w17338. Available at SSRN: https://ssrn.com/abstract=1918668

Greg Kaplan (Contact Author)

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

Giovanni L. Violante

New York University, Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
212-992-9771 (Phone)
212-995-4186 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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