Jeanne Commault, Sciences Po

"Heterogeneity in MPCs Beyond Liquidity Constraints: The Role of Persistent Earnings"

Abstract

Understanding the distribution of marginal propensities to consume (MPC) in the population is key to model the transmission of shocks and policies to the economy. Recent empirical findings are challenging the view that this distribution is mainly explained by liquidity constraints as: (i) many people with substantial liquid wealth have a high MPC; (ii) current earnings, which should relax the constraint, do not reduce the MPC. I note that a mechanism explaining (i)-(ii) is present in a standard life-cycle model with a transitory-permanent earnings process: when human capital is more risky than other assets, an increase in the permanent component scaling human capital strengthens precautionary behavior and raises the MPC. In survey data, this effect is present and large enough to explain (i)-(ii). Numerical simulations match the survey estimates when including a rich earnings process---which also raises the average MPC, to the same extent that illiquid wealth does.

Contact person: Jeppe Druedahl