Spending Response to a Predictable Increase in Mortgage Repayments: Evidence from Expiring Interest-Only Loans

We study how homeowners' consumption responds to a negative and anticipated disposable income shock: the beginning of the amortization period on interest-only mortgages. We identify spending behavior through an event study approach, by matching loan-level data that covers the universe of Danish mortgages to detailed administrative registries on borrowers. In response to an average increase in installments worth 9 percent of income, consumption drops by 3 percent of income, when amortization begins. The reduction in expenditure is persistent. Borrowers who fail to smooth consumption are highly leveraged and likely to be denied a new interest-only loan, upon expiration.

Wealth Inequality, Network Topology and Financial Instability

This paper asks if two, otherwise identical, economies were distinguished only by their distributions of wealth, are they equally stable in response to a random shock? A theoretical financial network model is proposed to understand the relationship between wealth inequality and financial crises. In a financial network, financial assets link individual asset and liability holders to form a web of economic connections. The total connectivity of an individual is described by their degree, and the overall distribution of connections in the network is imposed through a degree distribution--equivalent to the wealth distribution as incoming connections represent assets and outgoing connections liabilities. A network's topology varies with the level of wealth inequality and total wealth and together, simulations show, they determine network contagion in the event of a random negative income shock to some individual. Random network simulations, whereby each financial connection is randomly placed, reveal that increasing wealth inequality makes a wealthy network less stable--as measured by the share of individuals failing financially or the decline in financial asset values. These results suggest a unique architectural role for accumulated assets and their distribution in macro-financial stability.

Estimating the Impact of Covid-19 and Policy Responses on Australian Income Distribution Using Incomplete Data

This paper undertakes a near real-time analysis of the income distribution effects of the Covid-19 crisis in Australia to understand the ongoing changes in the income distribution as well as the impact of policy responses. By semi-parametrically combining incomplete observed data from three different sources–the monthly Longitudinal Labour Force Survey, the Survey of Income and Housing and administrative payroll data–we estimate the impact of Covid-19 on the Australian income distribution and decompose its impact into the income shock effect and the policy effect between February and June 2020, covering the immediate periods before and after the initial Covid-19 outbreak. Our results suggest that, despite growth in unemployment, the Gini coefficient of equivalised household disposable income dropped by more than 0.02 points between February and June 2020. This reduction is due to the additional wage subsidies and welfare supports offered as part of the policy response, offsetting the increase in income inequality from the income shock effect. The results shows the effectiveness of temporary policy measures both in maintaining living standards and avoiding increases in income inequality. However, the heavy reliance on the support measures shown in the modelling raises the possibility that the changes in the income distribution may be reversed, or even that inequality and living standards could substantially worsen once the measures are withdrawn.

Living with Reduced Income: An Analysis of Household Financial Vulnerability Under COVID-19

The COVID-19 crisis has led to substantial reductions in earnings. We propose a new measure of financial vulnerability, computable through survey data, to determine whether households can withstand a certain income shock for a defined period of time. Using data from the ECB Household Finance and Consumption Survey (HFCS) we analyse financial vulnerability in seven EU countries. We find that, out of the 243 million individuals considered, 47 million are vulnerable to a three month long income shock (the average length of the first wave COVID-19 lockdown), i.e., they cannot afford food and housing expenses for three months without privately earned income. Differences across countries are stark. Individuals born outside the EU are especially likely to be vulnerable. Being younger, a single parent, and a woman are also statistically significant risk factors. Through a tax-benefit microsimulation exercise, we look into the COVID-19 employment protection benefits, the largest income support measure in the countries considered. Considering as our sample individuals in households where someone receives a salary, we derive household net income when employees are laid-off and awarded the COVID-19 employment protection benefits enacted. Our findings suggest that the employment protection schemes are extremely effective in reducing the number of vulnerable individuals. The relative importance of rent and mortgage suspensions, (likewise, widespread COVID-19 policies), in alleviating vulnerability, is highly country dependent.

Behavioral consequences and intervention of financial shocks

An increasing number of individuals report hardship to cover financial shortfalls, but most research to date examines expense shocks (e.g., a car repair) rather than income shocks (e.g., a one-time pay cut). Here we explore the behavioral consequences of expense and income shocks and propose a self-affirmation intervention to mitigate the psychological toll posed by financial shocks. In three experiments, participants were presented with a hypothetical financial emergency (i.e., a one-time income shock or expense shock) and answered questions afterwards. We found that income shocks evoked more methods of coping, were harder to cope with, more impactful on daily life, and perceived as more of a loss than expense shocks of the same amount. Self-affirmation as a behavioral intervention successfully mitigated some of the deleterious effects of the shocks. The findings contribute a more nuanced understanding of decision making in response to shortfalls by differentiating income and expense shocks. Our study suggests that there are psychological distinctions in how different financial shocks are perceived. This evidence can inform the strategies used to prevent and cope with financial emergencies and inform public policy to support household financial management.

Cash Transfers, Food Prices, and Nutrition Impacts on Ineligible Children

Can cash aid harm non-recipients by raising local prices? We show that a householdtargeted cash transfer in the Philippines increases the prices of perishable foods in some markets and raises stunting among non-beneficiary children by 11 percentage points (34 percent). Impacts increase in the size of the village income shock and remoteness-- and are sustained 2.5 years after program introduction. Price effects from an experimental sample are confirmed with national expenditure surveys collected during program scaleup. Household-targeted cash transfers can thus generate local spillovers that undermine program goals. Selected geographic targeting may avoid price spillovers at moderate additional cost.

Changes in fertility plans during the COVID-19 pandemic in Italy: the role of occupation and income vulnerability

The health and economic crisis generated by the COVID-19 pandemic is unprecedented in recent human history. We investigate the role of objective and subjective indicators of economic uncertainty due to the COVID-19 crisis in young Italians’ fertility plans during the year 2020. We use unique repeated cross-sectional data, collected at different time points during the pandemic (March and October/November 2020) together with pre-COVID data (2016). The data offer a standard fertility intention question pre- and during-COVID, and also a direct question on whether pre-COVID fertility plans have been confirmed, postponed or abandoned. We find that individuals with more vulnerable occupations show a lower probability of definitely intending to have a(nother) child in the short-term and a higher probability of having abandoned their pre-COVID fertility plan in March 2020, while in October 2020 changes in fertility plans did not vary by occupation. Instead, those who suffered from a negative income shock and those with negative expectations on their future income and occupation are more likely to abandon their pre-pandemic fertility plan compared to their better off counterparts, and these differences hold both in March and October. Overall, economic uncertainty generated by the pandemic seems to have similarly affected men and women’s fertility intentions. Our findings point to the fact that the unequal economic consequences of the pandemic also produced and will produce heterogeneous effects on fertility intentions.

Does income shock affect informal employment? Evidence from Russia

PurposeThe purpose of this study is to examine whether participating informality is attributed to income shocks such as wage arrears, unexpected wage cuts or compulsory unpaid leaves. The current research uses Russia longitudinal Monitoring Survey 2002–2015.Design/methodology/approachUsing formal jobs as the base category, the authors conducted pooled multinomial logit regressions allowing for the two additional employment statuses: workers without contracts and unincorporated business workers.FindingsThe overall results mainly suggest that no effects occur. In other words, unexpected negative income shocks are not the main driving force of informality. Although the majority of previous studies are based on survey questions on unexpected income shock which has sample selection bias, to obtain robustness, the current study used Russian minimum wage reforms as income shocks. This research shows that Russian minimum wage reform does not affect the decision of informality in the labor market.Research limitations/implicationsGiven the data limitations, the authors only observed and examined the supply-side of the labor market. Tax-evading motives would be the main reason for informality; to ensure this conjecture, however, demand and supply sides need to be simultaneously examined which is beyond the scope of this study.Originality/valueIn contrast to a large number of studies on cross-sectional differences in determinants of informal job holding, emphasis on the effects of income shocks on informal employment across business cycles has been minimal. The current study focuses on the business cycles because trends of informal employment can be interpreted differently regardless of whether in an economic boom or recession. Russia, as a unique natural experiment, provides us to examine informal job holdings over the business cycle.

Income shock increases delay discounting independently of emotion

How to distribute resource consumption over time is a critical optimization problem. If an agent were to consume all available resources, they would be left with insufficient resources in the future. Inversely, if an agent were to save all their resources for later, they might not live long enough to consume them. The first error is common due to “temporal discounting” - the tendency to value immediate rewards over equivalent future rewards. A major research goal is to identify the factors that influence the temporal discounting rate, so that policy makers could develop interventions to correct for imbalance. It has been shown that a negative change in life circumstances, such as loss of income, is associated with an increase in temporal discounting. Interestingly, negative affect is also associated with increased temporal discounting. Here, we test whether both negative income shock and negative affect lead to greater temporal discounting, and whether they do so independently. We tested 1,145 individuals as the market was crashing in late March 2020 and unemployment rising due to the COVID-19 crisis and then retested 200 individuals as the market was recovering in June 2020. We found that income shock was strongly related to an increase in delay discounting using cross-sectional and longitudinal data. Importantly, this relationship was independent of the negative impact on affect. These findings suggest that the link between income change and delay discounting is a direct result of liquidity constraints, not of changes in affect. This independence may be adaptive, as affect is a noisy reflection of environmental constraints, which may introduce noise to the decision problem leading to suboptimal choice.

Job Displacement Insurance and (the Lack of) Consumption-Smoothing

We study the spending profile of workers who experience both a positive transitory income shock (lump-sum severance pay) and a negative permanent income shock (layoff). Using de-identified expenditure and employment data from Brazil, we show that workers increase spending at layoff by 35 percent despite experiencing a 14 percent long-term loss. We find high sensitivity of spending to cash-on-hand across consumption categories and for several sources of variation, including predictable income drops. A model with present-biased workers can rationalize our findings, and highlights the importance of the timing of benefit disbursement for the consumption-smoothing gains of job displacement insurance policies. (JEL D12, G51, J65, J63, O12)