How do income and the debt position of households propagate fiscal stimulus into consumption?

Abstract

Expansions in public spending induce a surge of private consumption that is accompanied by increasing post-tax income of households, on average, during the U.S. postwar era. Endogenously reacting income, however, appears insufficient to fully rationalize conditional co-movement of private and public spending: private spending even expands in times during which disposable income does not rise, and for medium-income household groups that do not experience income gains. Corroborating these observations, we show within a SVAR-IV framework that fiscal stimulus causally prompts households to take on more credit. This favorable debt cycle is paralleled by dropping credit rates/spreads and inflating collateral prices, e.g., real estate prices, suggesting that softening borrowing constraints support the accumulation of private debt and help rationalizing the absence of consumption crowding-out.