A model of expenditure shocks

A common observation from account-level bank data is that low-income, low-liquidity households often use additional income to repay debt rather than consume, and that household-level consumption is extremely volatile even though aggregate consumption is smooth. This paper formalizes these patterns using four new facts from the PSID: household consumption is as volatile as income (contradicting PIH); the correlation between household consumption and income growth is only about 0.2 (low); consumption growth is negatively autocorrelated (contradicting both PIH and habit models); and—a finding new to the literature—the cross-sectional correlation between consumption and income growth is far smaller among households experiencing high consumption episodes than in the full sample. The paper proposes an explanation based on stochastic consumption thresholds: unanticipated shocks such as medical expenses or vehicle repairs create time-varying minimum-consumption floors whose violation incurs large utility costs, inducing households to prioritize expenditures on these needs over income-responsive consumption and to rebuild savings after the shock. This mechanism increases the welfare cost of income fluctuations by an order of magnitude relative to standard models.

Demand Stimulus as Social Policy

This paper estimates the distributional and social consequences of Department of Defense (DOD) contract spending using a city-level (CBSA) panel dataset spanning 2005–2016. The research question is whether demand stimulus — specifically DOD spending, the largest category of U.S. discretionary government spending — has differential effects across demographic groups and whether it improves social outcomes typically targeted by dedicated government programs. A secondary question is whether these effects are specific to DOD spending or common to any demand shock.

Daniel Murphy | Macro Paper Warehouse

A model of expenditure shocks

Demand Stimulus as Social Policy