Borrowing in Response to Windfalls

Arna Olafsson, Michaela Pagel

Research output: Contribution to conferencePaperResearchpeer-review

Abstract

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.
Original languageEnglish
Publication date2020
Number of pages52
Publication statusPublished - 2020
EventAEA Annual Meeting 2020 - San Diego Marriott Marquis & Marina, San Diego, United States
Duration: 3 Jan 20205 Jan 2020
https://www.aeaweb.org/conference/2020

Conference

ConferenceAEA Annual Meeting 2020
LocationSan Diego Marriott Marquis & Marina
CountryUnited States
CitySan Diego
Period03/01/202005/01/2020
Internet address

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