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 con sume (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 un secured 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., borrow ing capacity. The larger-than-one MPCs are thus nanced 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 indi viduals do not increase their savings in response to either small or large windfalls. Our ndings point to overconsumption problems driving both high MPCs as well as large consumer debt holdings and are clean evidence against liquidity constraints as an ex planation for high MPCs out of windfalls
Original languageEnglish
Publication date2021
Number of pages56
Publication statusPublished - 2021
EventThe 81st Annual Meeting of American Finance Association. AFA 2021: Part of the ASSA 2021 Virtual Annual Meeting - Virtual
Duration: 3 Jan 20215 Jan 2021
Conference number: 81
https://www.aeaweb.org/conference/2021

Conference

ConferenceThe 81st Annual Meeting of American Finance Association. AFA 2021
Number81
LocationVirtual
Period03/01/202105/01/2021
Internet address

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