FISCAL STIMULUS AND CONSUMER DEBT Yuliya Demyanyk, Elena Loutskina, and Daniel Murphy* Abstract—In the aftermath of the consumer debt–induced recession, pol- In this paper, we use detailed new data on Department of icymakers have questioned whether fiscal stimulus is effective during pe- Defense (DOD) spending to evaluate whether government riods of high consumer indebtedness. This study empirically investigates this question. Using detailed data on Department of Defense spending for spending during the Great Recession stimulates local eco- the 2007–2009 period, we document that the open-economy relative fiscal nomic growth differently across geographies with varying multiplier is higher in geographies with higher consumer debt. The results levels of prerecession consumer indebtedness. We find that suggest that in the short term (2007–2009), fiscal policy can mitigate the adverse effect of consumer (over)leverage on real economic output dur- consumer debt is an important determinant of the fiscal mul- ing a recession. We then exploit detailed microdata to show that both het- tiplier during the Great Recession. During the 2007–2009 erogeneous marginal propensities to consume and slack-driven economic period, the DOD spending multiplier is higher in geogra- mechanisms contribute to the debt-dependent multiplier. phies with higher prerecession consumer debt-to-income ra- tios than in geographies with lower prerecession consumer debt-to-income ratios.2 We then exploit detailed microdata I. Introduction to evaluate whether aggregate demand and aggregate sup- HE ability of government spending to mitigate recessions ply economic mechanisms contribute to the debt-dependent Thas always been a hotly debated topic among academics, multiplier. practitioners, and policymakers. The 2007 crisis brought new Our analysis is based on DOD spending data that cover pur- arguments to the table as it acutely highlighted the role that chases and obligated funds from $25 to multimillion-dollar consumer indebtedness plays in a recession (Mian & Sufi, contracts since 2000. We observe the start and end dates of 2011). The dramatic rise in U.S. household leverage from the contracts, the primary contractor locations, and the postal about a 1.2 debt-to-income ratio in late 1990 to about 1.65 code in which the majority of the work was performed. Armed in 2006 not only set the stage for the Great Recession but with the granular DOD spending data, we combine the em- also contributed to a decline in aggregate consumption and pirical approaches of Mian and Sufi (2015) and Nakamura ultimately slowed the economic recovery (Mian, Rao, & Sufi, and Steinsson (2014) to implement an instrumental variable 2013; Mian & Sufi, 2015). It is unclear whether fiscal stimulus analysis that evaluates how prerecession consumer debt-to- is effective in this environment. income ratios and the change in DOD spending from 2007 to Consumers’ debt and subsequent deleveraging are fre- 2009 affect economic output over this period. The detailed na- quently invoked to argue that expansionary fiscal pol- ture of this new DOD spending data allows us to conduct the icy might be ineffective during consumer-debt-overhang- analysis at the core-based statistical area (CBSA) level and induced slumps.1 These arguments are bolstered by evidence hence better capture the heterogeneity in consumer leverage. that household deleveraging may be associated with low Moreover, it permits us to focus on the recessionary period spending propensities (Sahm, Shapiro, & Slemrod, 2015; with high total consumer debt and rapid deleveraging by con- Jappelli & Pistaferri, 2014) that should lead to low short-run ducting a purely cross-sectional analysis. fiscal multipliers. At the same time, the proponents of de- Our results suggest that DOD spending multipliers ex- mand stimulus argue that expansionary fiscal policy is more hibit significant heterogeneity across CBSAs with different effective during periods of consumer deleveraging due to high prerecession levels of consumer leverage. The difference in spending propensities (Eggertsson & Krugman, 2012). While the multiplier between the 75th and 25th percentiles of the some theoretical literature sheds light on this debate, few pa- consumer-leverage distribution is about the same as the aver- pers empirically examine this question. age CBSA open-economy fiscal multiplier.3 The results sug- gest that at least in a short to medium run, expansionary fiscal stimulus during a deleveraging recession can mitigate the ad- verse effects of consumer debt overhang on economic growth: Received for publication September 13, 2017. Revision accepted for pub- a 1 percentage point increase in government spending rela- lication June 25, 2018. Editor: Yuriy Gorodnichenko. ∗Demyanyk: University of Illinois at Chicago; Loutskina: University of tive to local income offsets the adverse effects of consumer Virginia, Darden School of Business; Murphy: University of Virginia. indebtedness by about 16%. The views expressed are those of the authors and do not necessarily reflect the official positions of the Federal Reserve Bank of Cleveland or the Federal Reserve System. A supplemental appendix is available online at http://www.mitpress 2Throughout our analysis, we exploit total consumer indebtedness that journals.org/doi/suppl/10.1162/rest_a_00796. accounts for all types of debt balances: mortgages, auto loans, credit card 1In his 2010 speech promoting austerity, U.K. Chancellor of the Exche- debt, and other forms of consumer credit. For simplicity, we refer to it as quer George Osborne asserted, “We have to move away from an economic consumer debt. modelthatwasbasedonunsustainableprivateandpublicdebt....There 3We adopt Nakamura and Steinsson’s (2014) terminology in referring is no choice between going for growth today and dealing with our debts to multipliers estimated from cross-regional variation as “relative open- tomorrow. Indeed we will not have meaningful growth unless we show we economy multipliers.” See Chodorow-Reich (2019) for a discussion of the can deal with our debts” (https://conservative-speeches.sayit.mysociety.org relationship between estimates of open-economy multipliers and fiscal mul- /speech/601526). tipliers derived from national aggregate data. The Review of Economics and Statistics, October 2019, 101(4): 728–741 © 2019 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology https://doi.org/10.1162/rest_a_00796 Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/rest_a_00796 by guest on 01 October 2021 FISCAL STIMULUS AND CONSUMER DEBT 729 In the second half of the paper (section IV), we examine with the local consumer debt-to-income ratio, despite con- the validity of two economic mechanisms that could con- sumer leverage having no direct effect on employment in tribute to the debt-dependent multiplier. First, fiscal multipli- this sector. The dependence of this multiplier on prerecession ers might depend on debt-driven heterogeneity in marginal consumer indebtedness suggests that slack dependence may propensities to consume (MPCs). Galí, López-Salido, and also contribute to debt-dependent multipliers during the Great Vallés (2007) and Eggertsson and Krugman (2012) suggest Recession. that consumption of high-debt, credit-constrained house- Overall, our results indicate that the benefits of fiscal holds responds strongly to fiscal stimulus, while consump- stimulus—higher income and employment—are higher in tion of nondebt-constrained agents is relatively unaffected by geographies suffering from consumer debt overhang. While additional income. The resulting higher MPCs among highly we explore only the relative multiplier and do not evaluate levered leveraged consumers should lead to higher fiscal mul- the long-term costs of fiscal stimulus (e.g., public debt and tipliers. In contrast, recent empirical studies document that future tax burdens), our results offer an important implica- high-debt households use additional income to pay down debt tion: the ills of private debt overhang can be mitigated, at rather than to spend (Sahm et al., 2015; Jappelli & Pistaferri, least in the short run, by government spending. Fiscal policy 2014). These studies suggest that deleveraging can be associ- is relatively more effective at stimulating income and em- ated with less effective fiscal policy if debt-ridden households ployment in areas with high consumer debt-to-income ra- are characterized by lower MPCs. tios compared to areas with low consumer debt-to-income We use detailed microdata to evaluate whether govern- ratios. ment spending leads to higher consumption responses for This paper contributes to a number of strands of literature high-debt households. Specifically, we exploit individual- on fiscal policy and consumer behavior. First, we contribute to level measures of consumer debt-to-income ratios along with the debate about the efficacy of fiscal policy during consumer- two measures of household consumption: (a) individual-level debt-overhang-induced slumps. Inspired by the 2007 crisis, consumer credit card balances and (b) postal code–level new an emerging theoretical literature explores optimal policy car registrations.4 We find that consumption of high debt-to- during recessions that feature financial frictions and hetero- income households responds more positively to an increase geneous consumers (Guerrieri & Lorenzoni, 2017; Eggerts- in DOD spending during the crisis period than consump- son & Krugman, 2012). On the empirical side, Bernardini