The Marginal Propensity to Consume out of Liquidity

This paper presents novel tests of competing models of intertemporal consumption behavior using unique European administrative panel data on income, spending and assets. I estimate the marginal propensity to consume (MPC) out of ‘liquidity’ -the debt response to a change in borrowing capacity- using changes in credit card limits in a randomized controlled trial implemented in September 2014 involving fifty-five thousand individuals. I obtain four empirical results: First, borrowing constraints change consumption dynamics even when they are not strictly binding. Two-thirds of the population accumulate a significant average of 20 cent of debt per dollar limit increase, relative to the control group. Second, the heterogeneity of the MPC is exclusively in line with precautionary models, a decreasing function of cash-on-hand. Third, the debt response to liquidity and credit card utilization are stationary. Fourth, additional liquidity is spent mostly on durables and services using installments, with a smaller fraction spent on non-durables and taken out as cash advances. I then use a workhorse Bewley model with realistic income risk and show that the joint dynamics of consumption, debt and the balance sheet in response to a change in borrowing constraints can be used to calibrate and test intertemporal models. Debt response to liquidity shocks identifies preference parameters via a simulated moments estimator. Hump-shaped debt response and mean-reverting credit card utilization are not consistent with myopia as the underlying preferences.