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The Liquid Hand-to-Mouth: Evidence from Personal Finance Management Software
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Spending responses to income are typically explained by households’ capital structures. Households that hold little or no liquid wealth have to consume hand-to-mouth. However, we find that few individuals hold little or no liquidity, and we document that liquidity holdings are much larger than predicted by state of the art models that explain spending responses with liquidity constraints due to illiquid savings. Given that present liquidity constraints do not bind, we analyze whether individuals hold liquidity cushions to cope with future liquidity constraints. To that end, we analyze cash-holding responses to income payments inspired by the corporate finance literature. However, we find that individuals’ cash-holding responses are consistent with standard models without illiquid savings, and neither present nor future liquidity constraints being frequently binding. Because these models are inconsistent with payday responses, we feel that the evidence suggest the existence of “liquid hand-to-mouth” households that spend heuristically.
Author: Arna Olafsson, Micheala Pagel
Topic: Financial behaviour/decisions
Location: Denmark
Format: Report
Content Type: Research
Publication Date: November 9, 2016