Copenhagen was the third stop on my tour campaigning for the elimination of the zero lower bound. At the University of Copenhagen I also learned that the Danes were ahead of me on my “National Rainy Day Accounts” proposal. The Danes are showing the way toward technocratic stabilization policy for nations that share their monetary policy with other countries and sometimes need something more than the common monetary policy. (Denmark is not in the eurozone, but by long and hallowed custom has kept a fixed exchange rate relative to the mark and then the euro, so now it effectively shares its monetary policy with the eurozone.) 

I am delighted to be able to host this guest post by David Dreyer Lassen, Claus Thustrup Kreiner and Søren Leth-Petersen on the Danish use of national rainy day accounts, based on their research:

How is it possible to stimulate the economy when traditional monetary and fiscal policy instruments are exhausted? Using an unprecedented policy tool the Danish government allowed people in 2009 to prematurely withdraw pension funds that were previously collected into individual accounts through a government mandate, thereby letting people spend their own money while leaving the government budget unaffected. Such a policy will have significant effects on spending if people are liquidity constrained. Evidence from a new study confirms this conjecture.

From 1998 to 2003 almost all Danes contributed 1% of their income to a mandatory pension plan, the so-called Special Pension (SP) savings plan. The funds were kept in individual, non-accessible accounts and were to be paid out starting at the public retirement age. Taking the entire population (as well as pundits and commentators) by surprise, on March 1, 2009 the government suddenly announced that the funds accumulated could be withdrawn during a window starting 1 June 2009 and ending 31 December 2009. The objective of the policy was to stimulate household spending. 

The policy is interesting for several reasons: First, the Danish stimulus policy changed the timing of access to the individual funds while leaving individual wealth unaffected. Spending the pension funds today directly lowers consumption possibilities in the future. In this sense, the Danish stimulus policy implicitly imposed Ricardian equivalence at the micro level, and is thus almost ideal for measuring the importance of liquidity constraints for the spending response. Second, the payout was large. 70% of the population aged 25 or more had accounts. Almost 95% of all funds were taken out. The average individual payout amounted to approximately 1900 USD after taxes, and the total payout amounted to about 1.4% of GDP. Third, the policy was transparent and funds easy to access: All account holders received a personal letter stating the balance of the account. To have the balance paid out, account holders should sign a slip and return it in an enclosed, stamped envelope. The money would then be transferred directly to the holder’s main bank account, already on file. Finally, the policy was announced without any previous discussion in the public. This is important for measuring the effect of the policy because it makes it possible to bound the time frame where possible spending responses could be observed.

To measure the spending effect of the reform, we conducted a telephone survey in January 2010, just after the payout window had closed, resulting in about 5,000 completed interviews with information about spending behavior related to the SP-payout. The survey indicates that almost 65% of the respondents used the entire payout for increasing their spending, corresponding to almost 2% of total private spending in 2009.

To get further insight into whether this huge spending effect is driven by individuals affected by liquidity constraints, we match the survey data at the person level to income tax records and other administrative registers with information about household characteristics, income, and broad categories of financial assets for the period 1998-2009. In addition, we exploit a novel administrative data set that provides third party reported information about all individual deposit and loan accounts held by our survey respondents in 2007-2008. These data enable us to calculate account specific interest rates and, based on this, to estimate the interest rate on marginal liquidity for 2008 for each survey respondent and their household. 

These household specific marginal interest rates represent a measure of the interest wedge between borrowing and lending rates, and is a continuous measure of the intensity of liquidity constraints. We correlate them with information about the propensity to spend the stimulus from the survey. The result is presented in the figure at the top of the post showing a strikingly linear and significant relationship between the propensity to spend the stimulus and the marginal interest rate.  

The correlation is significant also when controlling for a number of covariates including income, financial asset holdings, demographics and expectations regarding future economic constraints, showing that the marginal interest rate is a robust predictor of the propensity to spend the stimulus. This suggests that credit market imperfections are important for explaining consumption responses to stimulus policies ̶ just as standard theory suggests. 

Why do households face different interest rates? We use the longitudinal aspect of the administrative data and show that the level of financial assets held by the same households more than a decade earlier is negatively correlated with the marginal interest rate that we measure just before the stimulus. In other words, those individuals who held the least financial assets in 1998 face the highest marginal interest rates in 2008. Further, when we isolate the variation in marginal interest rates across households that is due to persistent differences in financial behavior, we find that the slope is five times steeper than the gradient illustrated in the figure, that is persistent differences in financial behavior impact the interest rate-spending gradient more than what appears from the raw correlation. This result holds up, and is actually reinforced, when we consider a subsample of individuals (about 50% of the original sample) who have never been unemployed during the last ten years before the stimulus. Overall, these results suggest that differences in liquidity constraint tightness across consumers, observed just before the stimulus policy implementation, reflect heterogeneity across consumers that is persistent to a degree that cannot be accounted for by shocks appearing within the horizon of a typical business cycle. The effectiveness of the policy thus appears to be rooted in persistent differences in financial behavior across households, although other factors, such as size effects, may also play a role.

The policy is remarkable in several respects. It leaves person level wealth unaffected and exploit differences in financial behavior across the population to generate spending effects that are significant at the macro economic level. Moreover, by letting people spend their own money, it has no direct effect on the fiscal budget, and may even have positive derived effects from increased activity. Thus, this type of policy may be a new way to stimulate depressed economies when standard fiscal policies are limited, for example because of high levels of sovereign debt.

This guest post is based on a research paper written by the three of us–Claus Thustrup Kreiner, David Dreyer Lassen, and Søren Leth-Petersen: “Liquidity Constraint Tightness and Consumer Responses to Fiscal Stimulus Policy.” The paper can be downloaded here.

Don’t miss the related posts:

• Getting the Biggest Bang for the Buck in Fiscal Policy
• National Rainy Day Accounts
• Joshua Hausman on Historical Evidence for What Federal Lines of Credit Would Do
• Joshua Hausman: More Historical Evidence for What Federal Lines of Credit Would Do
• How Italy and the UK Can Stimulate Their Economies Without Further Damaging Their Credit Ratings
• Preventing Recession-Fighting from Becoming a Political Football
• Noah Smith Joins My Debate with Paul Krugman: Debt, National Lines of Credit, and Politics
• After Crunching Reinhart and Rogoff’s Data, We Found No Evidence High Debt Slows Growth

(Note that as long as some decision makers think debt is a problem, it will lead to underuse of traditional fiscal policy, so that a national rainy day account policy is helpful in getting around fear of debt even in situations where national debt itself is not a problem.)