Speaker: Kieran Walsh (Darden School of Business, UV)
Theme: "Debt Burdens and the Interest Rate Response to Fiscal Stimulus: Theory and Cross-Country Evidence" joint with Jorge Miranda-Pinto, Daniel Murphy, and Eric Young
Abstract: We document that the interest rate response to fiscal stimulus (IRRF) varies widely across countries. In half of OECD countries fiscal shocks increase interest rates while in the other half they cause interest rates to decline. To interpret this evidence we develop a model in which households have minimum consumption constraints. In equilibrium, many households with low wealth hit this constraint and take on debt in the face of adverse shocks. Now debt-burdened, these households use additional income to delever. In economies with more debt-burdened households, increases in government spending tighten credit conditions less (relax credit conditions more), leading to smaller increases (larger declines) in the interest rate. Using data on debt and consumption from the Panel Study of Income Dynamics, we show that low-wealth households behave as predicted by the model. We explore a number of theoretical proxies for the fraction of debt-burdened households, such as inequality and outstanding consumer credit. We show that variation in the IRRF depends on these proxies, consistent with the theory.