Stimulus through Insurance: the Marginal Propensity to Repay Debt

Using detailed microdata, we document that households often use “stimulus” checks to pay down debt, especially those with low net wealth-to-income ratios. To rationalize these patterns, we introduce an empirically plausible borrowing price schedule into an otherwise standard incomplete markets model. Because interest rates rise with debt, borrowers have increasingly larger incentives to use an additional dollar to reduce debt service payments rather than consume. Using our calibrated model, we then study whether and how this marginal propensity to repay debt (MPRD) alters the aggregate implications of fiscal transfers. We uncover a trade-off between stimulus and insurance, as high–debt individuals gain considerably from transfers, but consume relatively little immediately. This mechanism lowers the immediate stimulus effect of fiscal transfers, but sustains aggregate consumption for longer.