The Economics of Financial Stress

Dmitriy Sergeyev (), Chen Lian () and Yuriy Gorodnichenko
Additional contact information
Dmitriy Sergeyev: Bocconi University
Chen Lian: UC Berkeley

No 16318, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: We study the psychological costs of financial constraints and their economic consequences. Using a representative survey of U.S. households, we document the prevalence of financial stress in U.S. households and a strong relationship between financial stress and measures of financial constraints. We incorporate financial stress into an otherwise standard dynamic model of consumption and labor supply. We emphasize two key results. First, a psychology-based theory of poverty traps requires two equally important components: financial stress itself and naivete about financial stress. Specifically, sophisticates save enough to escape high-stress states, because they understand that doing so alleviates the economic consequences of financial stress. On the other hand, naifs dis-save, fall into a poverty trap, and incur high welfare losses. Second, the financial stress channel can reverse the counterfactual negative wealth effect on labor supply because relieving stress frees up cognitive resources for productive work. Financial stress also has macroeconomic implications on wealth inequality and fiscal multipliers.

Keywords: behavioral economics; stress; survey; household finance (search for similar items in EconPapers)
JEL-codes: E7 G5 (search for similar items in EconPapers)
Pages: 85 pages
Date: 2023-07
New Economics Papers: this item is included in nep-ban, nep-cbe and nep-lma
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Published - published online in: Review of Economic Studies , 15 November 2024

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Working Paper: The Economics of Financial Stress (2023)
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