Saving Constraints, Debt, and the Credit Market Response to Fiscal Stimulus

45 Pages Posted: 4 Mar 2020

See all articles by Jorge Miranda-Pinto

Jorge Miranda-Pinto

University of Queensland

Daniel Murphy

University of Virginia - Darden School of Business

Kieran James Walsh

University of California, Santa Barbara (UCSB) - Department of Economics

Eric R. Young

University of Virginia

Multiple version iconThere are 2 versions of this paper

Date Written: February 27, 2020

Abstract

We document that the interest rate response to fiscal stimulus (IRRF) is lower in countries with high inequality or high household debt. To interpret this evidence we develop a model in which households take on debt to maintain a consumption threshold (saving constraint). Now debt-burdened, these households use additional income to deleverage. In economies with more debt-burdened households, increases in government spending tighten credit conditions less (relax credit conditions more), leading to smaller increases (larger declines) in the interest rate. Our theoretical framework predicts that the negative relationship between the IRRF and debt only holds when credit is not restricted. It also predicts that the consumption response to fiscal stimulus is falling in debt and inequality (only during periods of relaxed credit). We perform a series of empirical tests and find support for these predictions. In doing so, we provide context to recent evidence on the debt-dependent effects of government spending by highlighting that the relationship between debt and fiscal effects varies with credit conditions.

Keywords: interest rates, fiscal stimulus, household debt, inequality

JEL Classification: E62, E43, E21, D31, H31

Suggested Citation

Miranda-Pinto, Jorge and Murphy, Daniel and Walsh, Kieran James and Young, Eric R., Saving Constraints, Debt, and the Credit Market Response to Fiscal Stimulus (February 27, 2020). FRB of Cleveland Working Paper 20-07, Available at SSRN: https://ssrn.com/abstract=3547619 or http://dx.doi.org/10.2139/ssrn.3547619

Jorge Miranda-Pinto

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072
Australia

Daniel Murphy

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

Kieran James Walsh

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

Santa Barbara, CA

Eric R. Young (Contact Author)

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

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