Sahm, Shapiro, & Slemrod on Household Responses to Income Shocks

CLAUDIA SAHM, Federal Reserve Board
MATTHEW D. SHAPIRO, University of Michigan at Ann Arbor – Department of Economics, National Bureau of Economic Research (NBER)
JOEL B. SLEMROD, University of Michigan, Stephen M. Ross School of Business, National Bureau of Economic Research (NBER)

Balance-sheet repair drove the response of a significant fraction of households to fiscal stimulus following the Great Recession. By combining survey, behavioral, and time-series evidence on the 2011 payroll tax cut and its expiration in 2013, this papers identifies and analyzes households who smooth debt repayment. These “balance-sheet households” are as prevalent as “permanent-income households,” who smooth consumption in response to the temporary tax cut, and outnumber “constrained households,” who temporarily boost spending. The asymmetric spending response of balance-sheet households poses challenges to standard models, but nonetheless appears important for understanding individual and aggregate responses to fiscal stimulus.

[Ed.: One interpretation is that households have a rule of thumb for making debt payments, such as “$50 per month,” even though this results in lumpy (and therefore inefficient) consumption.  But this result may be superior to the utility outcome the household would get (bad credit, even less income smoothing) without the rule of thumb in place.  ]