DP17271 The Marginal Propensity to Consume in Heterogeneous Agent Models

Author(s): Greg Kaplan, Giovanni L. Violante
Publication Date: May 2022
Keyword(s): Borrowing Constraints, Consumption, hand-to-mouth, Heterogeneity, Income risk, liquidity, marginal propensity to consume, market incompleteness, precautionary saving, wealth distribution
JEL(s): D15, D31, D52, E21, E62, E71, G51
Programme Areas: Monetary Economics and Fluctuations, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17271

What model features and calibration strategies yield a large average marginal propensity to consume (MPC) in heterogeneous agent models? Through a systematic investigation of models with different preferences, dimensions of ex-ante heterogeneity, income processes and asset structure, we show that the most important factor is the share and type of hand-to-mouth households. One-asset models either feature a trade-off between a high average MPC and a realistic level of aggregate wealth, or generate an excessively polarized wealth distribution that vastly understates the wealth held by households in the middle of the distribution. Two-asset models that include both liquid and illiquid assets can resolve this tension with a large enough gap between liquid and illiquid returns. We discuss how such return differential can be justified from the perspective of theory and data.