Leverage, Hand-to-Mouth Households, and MPC Heterogeneity: Evidence from South Korea

This study examines the link between leverage, Hand-to-Mouth (HtM) status of households, and the marginal propensity to consume (MPC) out of income changes for South Korean households over 2012-2017. To build on previous studies, we provide an alternative definition of HtM households and examine the asymmetric effects of the direction of income changes on MPCs. By using the methodology of Hansen (2000), we estimate the threshold of the liquidity ratio (defined as liquid assets to monthly after-tax income) and find that households with liquid assets less than about two months of after-tax income show higher MPCs than others. We also find that the leverage ratio and newly defined HtM status show asymmetric effects on MPCs by the direction of income changes. The MPC of households with positive income changes is smaller than that of those with negative ones. Furthermore, HtM households with high leverage are much more sensitive to negative income changes than positive ones. This result suggests that in economic circumstances where households are highly in debt and have insufficient liquid assets, as in the South Korea economy, their consumption is likely to be vulnerable to negative income changes and this could hamper aggregate spending growth.