Title: Essays in Fiscal Policy and Consumer Finance
Description: During recessions, fiscal, monetary and other credit provision policies are used together to combat falling consumption levels and stabilize output. Most such counter-cyclical stabilization policies are deemed effective when households use provided credit or cash towards raising consumption. Hence, a deep understanding of consumer finance is central to understanding how and when such counter-cyclical stabilization policies work, and when they do not. In my dissertation, I focus primarily on one set of stabilization policies; namely fiscal stimulus. I provide particular empirical and theoretical insight into how consumers manage their finances and in particular liquidity levels, and how this behavior is connected to the effectiveness of fiscal policy during balance sheet recessions. I also discuss how the definition of effectiveness itself may need to undergo some revisions as applied to a balance sheet recession. Chapter 1 ``Heterogeneity in effectiveness of fiscal stimulus: The Economic Stimulus Payments of 2008" empirically investigates regional heterogeneity in the effectiveness of fiscal rebates during recessions characterized by housing crises.

While general estimates of the effectiveness have been measured in previous literature, the state dependence of such effectiveness to the particular type of business cycle state (for example depth of regional housing crisis) is unknown. I first provide a description of the 2008 recession, and the history of recent fiscal policies along with the institutional arrangement of the fiscal stimulus policies enacted during the time. I next review the relevant empirical literature on fiscal policy effectiveness. I then describe the empirical methodology to estimate the effectiveness of fiscal rebate policies in 2008 and their regional heterogeneity. Using a special module of the Nielsen Consumer Panel which surveys households about their 2008 Economic Stimulus Payments, I show that households' marginal propensity to consume (MPC) out of these rebates was significantly lower in zipcodes with larger declines in housing prices. This pattern holds for both households with liquid assets and for those without.

This highlights a novel finding compared to the previous literature; fiscal policy effectiveness is not explained solely by the behavior of households without liquid assets. These findings are not caused by differences in socio-economic and other observable characteristics and are robust to the use of a topology based instrument for housing price changes. Finally, I show that the results are driven by the difference in reported vs. revealed preference for reported savers and deleveragers in the hardest hit areas. Chapter 2 ``Policy and Theoretical Implications of Regional Heterogeneity in Fiscal Stimulus Effectiveness" investigates how the findings in Chapter 1 square with policy implications and consumption theory. On the policy side, I discuss how this result creates a policy dilemma, where fiscal stimulus may have been least effective in stimulating nondurable consumption in precisely the regions experiencing the worst recession. This underscores potential tradeoffs between the utilitarian and aggregate demand stabilization motives for rebate provision and the need to add nuance to the definition of fiscal policy effectiveness.

On the theory side, I revisit the theoretical consumption literature and describe its predictions for MPC in a time of lower incomes and wealth. In particular, I look at how the negative relation between MPC and house price decline is at odds with the predictions of canonical buffer-stock models, which predict a higher MPC in worse affected regions. Next, I build a state of the art heterogeneous agent life cycle model, which features adjustment costs, long term debt and a default option, and calibrate it to regional variation in housing price declines, unemployment risk and income declines. I discuss newer mechanisms which could potentially match the empirical results. In reality, I show that even such a model substantially overestimates the effectiveness of fiscal stimulus in the worst affected regions. I explore the reasons behind such a mismatch, including the lack of marginal deleveraging in the model. Finally, I use data from the Michigan Survey of Consumers to rule out regional variation in permanent expectations as a key variable which could reconcile the findings in the data.

Overall, the findings remain unreconciled with standard consumption theory, even after the augmentation of modern and realistic elements. Chapter 3 ``Evolution of Hand to Mouth Households (2007-09) and Lessons" continues on the theme of household liquidity which has been analyzed significantly to understand fiscal policy. A key parameter in the previous literature has been the proportion of illiquid households with housing wealth (also called wealthy hand to mouth households) who are important in understanding fiscal policy effectiveness. Two separate strands of the literature have emphasized either the role of permanent characteristics or income and wealth shocks (circumstance) in determining such status. In light of this, I document three new and robust findings. First, the overall proportion of such wealthy hand to mouth households stayed constant during the early years of the Great Recession. Second, there was massive underlying movement between various groups underneath the overall numbers.

Third, households who built liquidity buffers had significantly larger losses to housing wealth and smaller losses to permanent income expectations. They also achieved this improvement in liquidity through methods other than the extraction of illiquid assets. This implies households who build liquidity buffers during housing crisis recessions do so through cutting consumption sharply. Taken together, these findings imply a) that both circumstantial and characteristics views on household liquidity are important, and b) that consumption models with net illiquid assets cannot match central facts for balance sheet recessions. This is because they predict households building liquidity buffers through extraction of illiquid wealth, which is unavailable during such recessions. In contrast, models with asset valuation effects do a better job of matching the liquidity management decisions of households. The goal of my research is to inform debates on fiscal policy effectiveness and the linkages to household liquidity.

Future recessions with limitations on conventional monetary policy will especially be important times when these debates will play out. I hope this research provides useful information in the design and analysis of future counter-cyclical fiscal policies.