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A Model of the Consumption Response to Fiscal Stimulus Payments

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  • Kaplan, Greg
  • Violante, Giovanni L

Abstract

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8562.

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Date of creation: Sep 2011
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Handle: RePEc:cpr:ceprdp:8562

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Keywords: Consumption; Fiscal Stimulus Payments; Hand-to-Mouth; Liquidity;

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References

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. A Model of the Consumption Response to Fiscal Stimulus Payments
    by Christian Zimmermann in NEP-DGE blog on 2011-08-31 14:32:20
  2. Who spent the 2001 Bush tax rebate?
    by Economic Logician in Economic Logic on 2011-09-14 14:37:00
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