UPDATED: February 20, 2023

Imagine we dropped cash on every household in the country. Who would spend it? Who would save money? The answer to this question matters a great deal given the rise in inequality before the Great Recession. It also matters because the economy is likely to be demand-constrained during severe downturns, especially if the economy hits the zero-lower bound on nominal interest rates. If all households reacted to a cash windfall the same, then the distribution of income or wealth wouldn’t matter much for cyclical policy.

We argued in a previous post that  lower income/wealth households have a much higher propensity to spend out of cash windfalls. Another study supporting this claim is the Jappelli and Pistaferri (2013) study forthcoming in the American Economic Journal: Macroeconomics. They used answers to a 2010 survey in Italy that asked consumers how much of an unexpected cash windfall they would spend. The first notable result is that the average marginal propensity to consume out of a cash windfall shock was 48%. So 48% of the cash windfall would be spent on average.

Even more interesting, the authors found that the MPC was much larger for households that had lower “cash on hand.” Cash on hand is measured as household disposable income plus financial assets minus debt. So more casually speaking, households with high “cash on hand” are rich and those with low “cash on hand” are poor. Here is the key chart:

Average MPC by cash-on-hand percentiles

For the poorest households, the marginal propensity to consume was close to 70%. For the richest households, the MPC was only 35%. So even more evidence that lower income/wealth households spend a much larger fraction of cash windfalls.

The abstract makes the following policy conclusions:

“The results have important implications for the evaluation of fiscal policy, and for predicting household responses to tax reforms and redistributive policies. In particular, we find that a debt-financed increase in transfers of 1 percent of national disposable income targeted to the bottom decile of the cash-on-hand distribution would increase aggregate consumption by 0.82 percent. Furthermore, we find that redistributing 1% of national disposable income from the top to the bottom decile of the income distribution would boost aggregate consumption by 0.33%.”

In the face of a severe economic downturn, we think a better policy would be debt forgiveness, which would act as a transfer from higher income households who tend to own equity in the financial sector to lower income households who tend to have a lot of debt relative to assets or income. But the basic principle is the same: the distribution matters when devising cyclical policy.