Borrowing in Response to Windfalls

We use high-accuracy and comprehensive transaction-level panel data containing information on all spending, income, balances, and credit limits of a representative sample of the Icelandic population. We document that the marginal propensity to consume (MPC) out of small windfalls due to lottery payments, i.e., perfectly temporary unexpected income shocks, is larger than one for the average individual. Furthermore, we document that individuals who receive small windfalls increase their short-term unsecured consumer debt, such as overdrafts, in response. This borrowing response is prevalent for individuals having relatively little as well as a lot of liquidity, i.e., borrowing capacity. The larger-than-one MPCs are thus financed using expensive consumer
debt that is then rolled over for a considerable period of time. For large windfalls we only observe small MPCs and no borrowing responses. We also document that individuals do not increase their savings in response to either small or large windfalls. Our findings point to overconsumption problems driving both high MPCs as well as large consumer debt holdings and are clean evidence against liquidity constraints as an explanation for high MPCs out of windfalls.