Liquidity or Wealth? Consumption, Debt, and Financial Fragility After a Windfall

This paper examines how individual consumers adjust consumption and debt in response to a large, exogenous financial windfall, using Brazil’s 2017 FGTS reform, which allowed early access to previously illiquid severance fund balances. Leveraging rich administrative data linking credit registry and labor records, we use a difference-in-differences design exploiting quasi-exogenous eligibility timing based on birth month. We decompose the shock into liquidity and wealth components: the liquidity channel reflects early access to illiquid savings, while the wealth component arises from the present-value gain due to FGTS yields being persistently below market interest rates. Credit-constrained individuals primarily used the funds to reduce debt and lower default risk, while unconstrained consumers increased credit-financed spending, raising financial fragility. Liquidity components drove deleveraging and stability, whereas wealth components led to durable consumption and greater credit exposure. These results provide rare empirical validation of key Heterogeneous Agent New Keynesian (HANK) mechanisms and offer policy-relevant insights into how the composition of financial transfers influences consumer behavior and financial stability.