Fiscal Policy and Urban and Rural Residents’ Marginal Propensity to Consume

Abstract

Based on the optimal consumption decisions of representative households and the relationship between their decisions and fiscal policy, we evaluate the impact of China’s fiscal policy on urban and rural residents’ marginal propensity to consume. The result shows that since 1998 marginal propensity to consume has decreased by more than 20 percent, and the decrease is not only due to income distribution, economic development level, expectations, consumption structure and other factors, but also closely related to the application of fiscal policy. Among these factors, the overall impact of unanticipated fiscal policy shocks is significant and negative. The policy option of using unforeseen increases in tax revenue as a financing instrument greatly diminishes the positive effects of structural adjustment. Therefore, to increase household consumption, it is necessary not only to raise residents’ capacity for consumption by increasing fiscal revenue but also to stabilize consumer expectations and promote the marginal propensity to consume through adjusting fiscal revenue and expenditure policies.