FOI Seminar 25 November 2011

Søren Leth Petersen (Department of Economics, University of Copenhagen)
(with Claus Thustrup Kreiner and David Dreyer Lassen):

 

Consumer Responses to Fiscal Stimulus Policy:
Household Interest Rates and the Propensity to Consume

 

Friday 25 November 2011, 12.30-13.30, Building A, first floor (the B.S. Jørgensen seminar room)

Abstract:

During the recent economic crisis, many countries have tried to stimulate private consumption through active policy measures that increase cash-on-hand of households. Basic consumption theory extended with heterogeneity in interest rates predicts that households facing a high marginal interest rate on liquidity should respond more strongly to such policies than low-interest rate households. This is in contrast to the permanent income hypothesis, which assumes a common interest rate on illiquid and liquid wealth and predicts no consumption responses. We test directly whether household interest rate differentials between liquidity and illiquid assets can predict consumption responses to stimulus policy.

The 2009 Danish stimulus policy allowed two-thirds of the Danish adult population to withdraw compulsory pension savings during a seven month window. From a theoretical point of view, this reform provides a unique quasi experiment because it transforms illiquid wealth into liquid wealth at the household level. Our analysis combines survey information, where respondents are asked about their spending response to the policy, with third-party reported administrative records of program payouts and individual loans/deposits, allowing us to calculate household specific marginal interest rates. We find an average propensity to consume of 0.6, a large variation in marginal interest rates across households, and a strongly significant positive relationship between household consumption responses and marginal interest rates, as predicted by the theory. We also find that households observed with low levels of liquid assets in 1998, twelve years prior to the stimulus, have high marginal interest rates in 2009. This suggests that individuals observed with high interest rates at the time of the policy are impatient types.