Debt Burdens and the Interest Rate Response to Fiscal Stimulus: Theory and Cross-Country Evidence

Jorge Miranda-Pinto, Daniel Murphy, Eric Young and Kieran Walsh
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Daniel Murphy: University of Virginia
Kieran Walsh: University of Virginia

No 936, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: We document that the interest rate response to fiscal stimulus is lower in countries with high inequality. To interpret this evidence we develop a model in which households have minimum consumption constraints. In equilibrium, many households with low wealth hit this constraint and take on debt in the face of adverse shocks. 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. Using data from the Panel Study of Income Dynamics, we show that low-wealth households behave as predicted by the model.

Date: 2018
New Economics Papers: this item is included in nep-mac
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