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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.

Suggested Citation

  • Kaplan, Greg & Violante, Giovanni L, 2011. "A Model of the Consumption Response to Fiscal Stimulus Payments," CEPR Discussion Papers 8562, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8562
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    References listed on IDEAS

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    More about this item

    Keywords

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

    JEL classification:

    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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