9 May 2018

Stimulus Policy: Why Not Let People Spend Their Own Money?

Claus Thustrup Kreiner, David Dreyer Lassen and Søren Leth-Petersen

How is it possible to stimulate the economy when traditional monetary and fiscal policy instruments are exhausted? Using an unprecedented policy tool the Danish government allowed people in 2009 to prematurely withdraw pension funds that were previously collected into individual accounts through a government mandate, thereby letting people spend their own money while leaving the government budget unaffected. Such a policy will have significant effects on spending if people are liquidity constrained. Evidence from a new study by Kreiner, Lassen and Leth-Petersen confirms this conjecture.

From 1998 to 2003 almost all Danes contributed 1% of their income to a mandatory pension plan, the so-called Special Pension (SP) savings plan. The funds were kept in individual, non-accessible accounts and were to be paid out starting at the public retirement age. Taking the entire population (as well as pundits and commentators) by surprise, on March 1, 2009 the government suddenly announced that the funds accumulated could be withdrawn during a window starting 1 June 2009 and ending 31 December 2009. The objective of the policy was to stimulate household spending.

The policy is interesting for several reasons: First, the Danish stimulus policy changed the timing of access to the individual funds while leaving individual wealth unaffected. Spending the pension funds today directly lowers consumption possibilities in the future. In this sense, the Danish stimulus policy implicitly imposed Ricardian equivalence at the micro level, and is thus almost ideal for measuring the importance of liquidity constraints for the spending response. Second, the payout was large. 70% of the population aged 25 or more had accounts. Almost 95% of all funds were taken out.

The average individual payout amounted to approximately 1900 USD after taxes, and the total payout amounted to about 1.4% of GDP. Third, the policy was transparent and funds easy to access: All account holders received a personal letter stating the balance of the account. To have the balance paid out, account holders should sign a slip and return it in an enclosed, stamped envelope. The money would then be transferred directly to the holder's main bank account, already on file. Finally, the policy was announced without any previous discussion in the public. This is important for measuring the effect of the policy because it makes it possible to bound the time frame where possible spending responses could be observed.

To measure the spending effect of the reform, we conducted a telephone survey in January 2010, just after the payout window had closed, resulting in about 5,000 completed interviews with information about spending behavior related to the SP-payout. The survey indicates that almost 65% of the respondents used the entire payout for increasing their spending, corresponding to almost 2% of total private spending in 2009.

To get further insight into whether this huge spending effect is driven by individuals affected by liquidity constraints, we match the survey data at the person level to income tax records and other administrative registers with information about household characteristics, income, and broad categories of financial assets for the period 1998-2009. In addition, we exploit a novel administrative data set that provides third party reported information about all individual deposit and loan accounts held by our survey respondents in 2007-2008. These data enable us to calculate account specific interest rates and, based on this, to estimate the interest rate on marginal liquidity for 2008 for each survey respondent and their household.

Figure 1. The marginal propensity to spend and the marginal interest rate.

Figure 1. The marginal propensity to spend and the marginal interest rate.

Note: This figure is from Kreiner, Lassen and Leth-Petersen (2018). It presents a local polynomial regression of the marginal propensity to spend the 2009 stimulus, which is collected by survey in January 2010, on the household marginal interest rate calculated from third party reported data with information about all individual deposit and loan accounts in 2007-2008. The regression is based on 5,037 observations.  

These household specific marginal interest rates represent a measure of the interest wedge between borrowing and lending rates and is a continuous measure of the intensity of liquidity constraints. We correlate them with information about the propensity to spend the stimulus from the survey. The result is presented in Figure 1 showing a strikingly linear and significant relationship between the propensity to spend the stimulus and the marginal interest rate.

The correlation is significant also when controlling for a number of covariates including income, financial asset holdings, demographics and expectations regarding future economic constraints, showing that the marginal interest rate is a robust predictor of the propensity to spend the stimulus. This suggests that credit market imperfections are important for explaining consumption responses to stimulus policies  ̶  just as standard theory suggests.

The policy is remarkable in several respects. It leaves person level wealth unaffected and exploit differences in financial behavior across the population to generate spending effects that are significant at the macro economic level. Moreover, by letting people spend their own money, it has no direct effect on the fiscal budget, and may even have positive derived effects from increased activity. Thus, this type of policy may be a new way to stimulate depressed economies when standard fiscal policies are limited, for example because of high levels of sovereign debt.

Claus Thustrup Kreiner, David Dreyer Lassen, and Søren Leth-Petersen “Liquidity Constraint Tightness and Consumer Responses to Fiscal Stimulus Policy” Forthcoming American Economic Journal: Economic Policy