Saving Constraints, Debt, and the Credit Market Response to Fiscal Stimulus

Abstract

We document that the interest rate response to fiscal stimulus (IRRF) is lower in countries with high inequality or high household debt. To interpret this evidence we develop a model in which households take on debt to maintain a consumption threshold (saving constraint). Now debt-burdened, these households use additional income to deleverage. In economies with more debt-burdened households, increases in government spending tighten credit conditions less (relax credit conditions more), leading to smaller increases (larger declines) in the interest rate. Our theoretical framework predicts that the negative relationship between the IRRF and debt only holds when credit is not restricted. It also predicts that the consumption response to fiscal stimulus is falling in debt and inequality (only during periods of relaxed credit). We perform a series of empirical tests and find support for these predictions. In doing so, we provide context to recent evidence on the debt-dependent effects of government spending by highlighting that the relationship between debt and fiscal effects varies with credit conditions.

Effects of Fiscal Policy on Credit Markets

“…For example, Auerbach and Gorodnichenko (2017) document that, in a weak economy, a fiscal stimulus can lower the cost of public debt, consistent with the stimulus reducing the risk of a deep slump. Miranda-Pinto et al (2019) suggest that government spending can relax credit markets by redistributing income to savers. Murphy and Walsh (2018) posit that government spending transfers resources to the private sector and increases their saving, offsetting the credit-market-tightening effects of government bond issuance.…”

“…But there is a dearth of evidence to support the notion that government spending tightens credit markets (see Murphy and Walsh 2018 for a review). To the contrary, a growing body of evidence from the United States and other advanced economies suggests that government spending can cause a decline in long-term interest rates (e.g., Miranda-Pinto et al 2019). These studies point to a gap in economists' understanding of the relationship between fiscal stimulus and credit markets.…”

Inequality, fiscal policy and COVID19 restrictions in a demand-determined economy

“…This is a rather surprising result, given that inequality has often been associated with large shares of credit-constrained households (and hence potentially large fiscal multipliers, as in Brinca et al 2016 andLee 2020). However, recent empirical evidence documents an inverse relationship between fiscal effects and inequality (Miranda-Pinto et al 2020b;Yang 2017). Our theory and this evidence implies that household-level transfers are less effective during the recent episode of rising inequality.…”

Fiscal Multipliers in the COVID19 Recession

“…Our evidence adds to a growing literature on state-dependent fiscal effects. Much of this literature has examined whether fiscal multipliers vary across recessions and expansions (e.g., Auerbach and Gorodnichenko 2012;Ramey and Zubairy 2018), with the level of consumer debt (e.g., Demyanyk et al 2019;Klein 2017;Miranda-Pinto et al 2020a), or with the sign of the change in government spending (Barnichon et al 2020). We expand on this literature by examining how fiscal effects vary across lockdown status.…”