Academic journal article Brookings Papers on Economic Activity

The Wealthy Hand-to-Mouth

Academic journal article Brookings Papers on Economic Activity

The Wealthy Hand-to-Mouth

Article excerpt

ABSTRACT The "wealthy hand-to-mouth" are households that hold little or no liquid wealth, whether in cash or in checking or savings accounts, despite owning sizable amounts of illiquid assets (assets that carry a transaction cost, such as housing or retirement accounts). We use survey data on household portfolios for the United States, Canada, Australia, the United Kingdom, Germany, France, Italy, and Spain to document the share of such households across countries, their demographic characteristics, the composition of their balance sheets, and the persistence of hand-to-mouth status over their life cycle. The portfolio configuration of the wealthy hand-to-mouth suggests that these households may have a high marginal propensity to consume out of transitory income changes, a prediction for which we find empirical support in PSID data. We explain the implications of this group of consumers for macroeconomic modeling and fiscal policy analysis.

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A valuable framework for analyzing both household survey and aggregate time-series data on the joint dynamics of income and consumption is the life-cycle permanent-income hypothesis. Nevertheless, economists have long recognized that certain aspects of these data are at odds with some of this theory's most salient predictions. This is true for both the standard version of the theory (Friedman 1957; Hall 1978) and the more recent "buffer-stock" versions (Deaton 1991; Carroll 1997). At both micro and macro levels, it is common to estimate a large sensitivity of consumption to transitory changes in income, whereas according to the theory these income dynamics should be smoothed. (1) Moreover, expected consumption growth often fails to correlate with the real interest rate, a result that implies a breakdown of the forward-looking Euler equation holding with equality, as long as the elasticity of intertemporal substitution is not zero. (2)

The most direct way to account for these facts is through the existence of a sizable share of hand-to-mouth (HtM) consumers in the population, that is, consumers who spend all of their available resources in every pay period. HtM consumers have a high marginal propensity to consume out of transitory income changes, which could account for the high correlation between consumption and the transitory component of income growth, even for anticipated income shocks. Moreover, the Euler equation does not hold with equality for HtM consumers, and thus they are a source of misalignment between movements in the interest rate and movements in aggregate consumption growth. The main challenge to this view is the claim that micro data on household balance sheets suggest that the fraction of households with near-zero net worth, and hence those who consume all their income each period, is too small for the model to quantitatively reproduce the facts discussed above.

Measuring HtM behavior using data on net worth is consistent with the vast majority of equilibrium macroeconomic models with heterogeneous agents. These models feature either a single asset or two assets with different risk profiles (but the same degree of liquidity). Notable examples are the Bewley models, which feature uninsurable idiosyncratic risk and credit constraints, in the tradition of Mark Huggett (1996), S. Rao Aiyagari (1994), Jose-Victor Rios-Rull (1995), and Per Krusell and Anthony Smith (1998), and the spender-saver models, which feature impatient and patient consumers with complete markets, in the tradition of John Campbell and N. Gregory Mankiw (1989). Spender-saver models have been revived recently to analyze macroeconomic dynamics around the Great Recession by Jordi Gali, David Lopez-Salido, and Javier Valles (2007), Gauti Eggertsson and Paul Krugman (2012), and Alejandro Justiniano, Giorgio Primiceri, and Andrea Tambalotti (2013), among others. Models by Krusell and Smith (1997) and Christopher Carroll, Jiri Slacalek, and Kiichi Tokuoka (2014a, 2014b) combine the spender-saver insight of heterogeneity in patience with a standard one-asset incomplete-markets model. …

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