Effective fiscal stimulus: Transfers to illiquid households
Since the onset of the Great Recession, governments in advanced countries have been implementing stimulus programmes relying on fiscal transfers. The majority have been in the form of tax rebates or other measures aiming to increase households’ disposable income (Oh and Reis 2011), such as the voluntary suspension of pension contributions scheme recently introduced by the Italian government.
Fiscal transfers are successful in stimulating aggregate demand to the extent that they reach households with a high marginal propensity to consume (MPC). The long-standing question is how to identify – and to reach – the households that best qualify (Parker 2014, Jappelli and Pistaferri 2013). In line with the literature stressing credit market imperfections and precautionary saving, many empirical studies have shown that the marginal propensity to consume is higher among households with low level of ‘cash on hands’ (see, for instance, the recent study by Jappelli and Pistaferri 2014, based on survey data in Italy), and among households who are most likely to be liquidity constrained, as shown by Argarwal et al. (2007) in their study of the consumption response to the 2001 Federal income tax rebates.
A recent strand of the literature has called attention to the marginal propensity to consume of households who are relatively wealthy, but hold their wealth concentrated in assets (like housing) that are relatively illiquid. These are assets that, because of credit and financial frictions, can be used to finance current consumption only at high (transaction) costs. If borrowing against one’s house or refinancing one’s mortgage is very costly, homeowners may be discouraged from using their wealth to sustain current consumption in adverse circumstances (such as a temporary fall in income, or a surge in expenditure). When this is the case, the household can be described as ‘wealthy hand-to-mouth’ (Kaplan and Violante 2014), their consumption expenditure being quite sensitive to cash transfers that increase disposable income in the short run.
The challenge to the empirical literature is to shed light on the key mechanism supporting this conclusion, that is, on the ‘liquidity channel’ by which tax and transfers can affect demand.
The consumption response to liquidity-enhancing transfers: Evidence from Italian earthquakes
In a recent working paper (Acconcia et al. 2015), we take up the challenge of exploring micro evidence on the recent view concerning fiscal transfers. Our goal is to identify transfers whose main effect consists of raising the liquidity of relatively wealthy, but not necessarily liquid households, in a context characterised by frictions in credit markets.
The main idea of the study came from analysing public sector interventions in areas hit by major earthquakes in Italy. In support of the local population, the Italian government intervened by financing the costs of repairing work on damaged housing units. The recipients of these ‘reconstruction funds’ were not free to reallocate them across spending items; the transfers were specifically linked to housing repair work.1
However, since the households receive funds upfront, in principle they could use the cash to finance current consumption expenditure, against lower consumption in the future. In this respect, the transfers in our analysis are akin to short-term loans, accruing exclusively to owner-occupiers, who are relatively wealthy but may be illiquid.
We focus on three case studies: the earthquake in a large area comprising two Italian regions in the south of Italy (Campania and Basilicata) in 1980; the earthquake in the Emilia region in 2012; and the earthquake in the area around the city of L’Aquila in Abruzzo in 2009.2 In all of these cases, we analyse the impact response of the residents’ non-durable expenditure to reconstruction transfers, relying on data from the Bank of Italy Surveys of Household Income and Wealth (SHIW).3
These case studies are particularly suited to our purposes. First, the event (an earthquake) that defines the ‘treatment group’ (owner-occupiers in the disaster area eligible to reconstruction transfers) and ‘control groups’ (residents outside the disaster area and/or residents within the area not eligible to transfer) is random. In the disaster area, owner-occupiers both suffer from a random expenditure shock, due to the need of fixing damages to their housing, and benefit from the entitlement to reconstruction transfers.4 Second, the amount of the transfers is large relative to households’ current income.
Transfers have significant effects on consumption
With our first case study, the 1980 earthquake in the south of Italy, we establish a key result. Namely, relative to the owner-occupiers in the rest of Italy:
- Reconstruction transfers have no effect on consumption over a four-year time horizon, when the reconstruction work is implemented;
- Yet, the consumption by owner-occupiers responds quite strongly in the first two years after the earthquake. The initial increase is offset by a subsequent contraction, consistent with the fact that the transfers we analyse are not a gift, but a compensation for the cost of housing repair work.
Our estimate of the marginal propensity to consume out of the transfer is 22% – a result that is stable across alternative definitions of the control group, e.g. including residents in the disaster area not (yet) eligible to the transfer cash. For this case study, however, we do not have enough information to distinguish between wealthy-hand-to-mouth and others. The estimated marginal propensity to consume may be an average across groups of households with different marginal propensities to consume.
Increased consumption by illiquid households
With our second case study, the earthquake that hit the Emilia region in 2012, we refine our previous finding by exploiting richer information on the households’ portfolio composition, which was not yet included in the Bank of Italy surveys of the 1980s. Thanks to richer data, we can identify a group of wealthy-hand-to-mouth households and thus address more directly the hypothesis motivating our study.
Throughout our study, we identify illiquid (or wealthy hand-to-mouth) households with those that, before the earthquake: Held liquid assets (the sum of cash and bank deposits) amounting to less than 50% of their disposable income; and were in debt with a bank, e.g. they had a mortgage. About 20% of all homeowners fall in this group.
Here is the key finding:
- The consumption of homeowners in the earthquake area is significantly different from that of the control group only if they belong to the ‘wealthy hand-to-mouth’ group.
- Pooling all homeowners (independently of the liquidity of their wealth), our estimate of the marginal propensity to consume is very close to the estimate for the 1980 earthquake in the south of Italy – 27 vs. 22%.
- Splitting the sample according to our indicator of wealth liquidity, we show that the marginal propensity to consume out of transfer is 57% for the wealthy hand-to-mouth, while not significantly different from zero for the others.
The estimated marginal propensity to consume is high, but quite in line with the estimates in the literature. By way of example, Surico and Trezzi (2015) document a 50% decrease in the consumption of durables following a rise in Italian housing taxes.5
Increased consumption only if the transfer is in cash, not in kind
With our third case study we address the question of whether transfers are effective in raising households’ consumption when ‘paid out in kind’, rather than in cash. According to theory and our early results, they should not be.
In the aftermath of the earthquake that hit the area around the city of L’Aquila in the Abruzzo region in 2009, the government implemented a massive reconstruction programme. However, instead of giving cash to households, the government agencies paid directly the construction companies carrying out the work.
- Unlike the previous cases, we find no significant response of households’ consumption to transfers in kind (reconstruction services), regardless of the liquidity of their wealth and bank debt.
This result complements our previous finding that reconstruction transfers have no effect on consumption over a four-year horizon, reinforcing our main conclusion – namely, what drives the short-run response in consumption is the short-run liquidity effect of the cash accruing to illiquid households.
The evidence from our case studies lends support to recent views of the way in which fiscal stimulus affects demand, stressing liquidity effects.
The main message from our analysis, as well from a number of other recent studies, is straightforward. A well-designed programme of temporary transfers, targeted to relatively wealthy but possibly illiquid households, can be quite helpful in (European) economies still in a recessionary state, as a way to speed up recovery. Measures sustaining economic activity may be especially desirable in countries that are currently implementing far-reaching structural reforms.
Acconcia, A, G Corsetti, and S Simonelli (2015), “The Consumption Response to Liquidity-Enhancing Transfers: Evidence from Italian Earthquakes”, CEPR Discussion Paper 10968.
Agarwal, S, C Liu, and N S Souleles (2007), “The Reaction of Consumer Spending and Debt to Tax Rebates-Evidence from Consumer Credit Data”, Journal of Political Economy, December, 115 (6), 986–1019.
Jappelli, T and L Pistaferri (2014), “Fiscal Policy and MPC Heterogeneity”, American Economic Journal: Macroeconomics, October 2014, 6 (4), 107–36.
Jappelli, T and L Pistaferri (2013), “Fiscal policy and consumption”, VoxEU.org, 23 March.
Kaplan, G and G L Violante (2014), “A Model of the Consumption Response to Fiscal Stimulus Payments”, Econometrica, 82 (4), 1199–1239.
Parker J A (2014), “The effectiveness of tax rebates as countercyclical fiscal policy”, VoxEU.org, 17 June.
Oh, Hyunseung and R Reis (2011), “The fiscal expansion of 2007-09: All about transfers”, VoxEU.org, 4 May.
Surico, P and R Trezzi (2015), “Consumer Spending and Property Taxes: Evidence from the 2011 Italian IMU,” Mimeo, 2015.
1 Costs were pre-set according to strict technical criteria and typically there was a cap on financing – say, only up to 110 square meters of reconstruction.
2 See our working paper for institutional details on the transfer programmes in each of these three cases.
3 In our study, a specific reason not to include durables in our study is to avoid the risk of confounding consumption/saving decisions with the need to replace items lost in the earthquake.
4 It is worth stressing that the stock of housing in the area of our interest consists of historical buildings not conforming to anti-seismic norms – luxury and ordinary units are similarly vulnerable to damages from earthquakes. By this feature of the sample, damages and thus the amount of public transfers is unlikely to be systematically related to the households’ wealth and liquidity levels.
5 By now it is by well understood that upfront fiscal measures, dictated by, say, the need to ‘show the money’ to foreign creditors and investors, have a large cost in terms of domestic demand and employment. Our analysis suggests that, for illiquid households, the contraction in demand could be strong also when these measures are perceived to be strictly temporary.