Household Balance Sheets, Default, and Fiscal Policy at the Zero Lower Bound

Christoph Boehm

No 1195, 2015 Meeting Papers from Society for Economic Dynamics

Abstract: Weak household balance sheets and household defaults were ubiquitous during the Great Recession and the subsequent recovery. In this paper I argue that both, weak balance sheets and default play a role for the effectiveness of fiscal policy. To do so, I develop a model in which weak balance sheets naturally cause households to use income from government transfers to pay down debt. Nevertheless fiscal policy can stimulate aggregate demand in this environment. The reason is that transfers to borrowers also prevent some households from defaulting. These households continue to borrow which -- under plausible conditions -- raises aggregate demand at the zero lower bound. The main conclusion is that marginal propensities to consume are not sufficient to characterize the effects of fiscal policy.

Date: 2015
New Economics Papers: this item is included in nep-dge
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