Economic stimulus and the marginal propensity to consume

This is a guest post from Kevin, who writes about getting and staying out of debt at No-Debt Plan. Previously at GRS, Kevin wrote about the power of attentive spending.

Many Americans will begin receiving a few extra dollars in their paychecks this month. Thanks to the latest round of economic stimulus from the federal government, the monthly take-home pay of most workers will increase by about $50. Economists and politicians hope that this is enough to prompt recipients to spend. They want us to buy our way out of this recession.

The government tried something similar last year. But in 2008, the stimulus payments were issued as lump sums. Last year's stimulus didn't have the intended effect; large chunks of the population used the money to build savings or to pay down debt.

This time, however, you won't be getting a check in the mail; the government has elected to simply reduce withholding taxes on our paychecks. The last round of stimulus checks cost millions of taxpayer dollars in postage and printing costs. (First with a letter telling us the checks were coming — then with the actual check!) At least they haven't done that again.

That's an obvious reason we won't be getting a check. But there's something much more subtle going on that I want to make you aware of.

The Marginal Propensity to Consume

Marginal propensity to consume (MPC) is a fancy economic measure that shows how much more you're likely to spend when your income goes up. If the United States' average MPC is 90%, then for every extra dollar you earn (or are given) as an average American, you are likely to spend 90 cents of it as disposable income. And if you've paid any attention to our national savings rate recently, you might come to the conclusion that as a society we've been dancing right on the 99% MPC line. (That is, we spend 99% of every extra dollar we bring home.)

Whether or not it's the intention of the government, they're utilizing marginal propensity to consume with this tax/stimulus decision. Stretching out your stimulus “check” over nine months increases the likelihood that you will:

  • not notice the difference in your check, and
  • spend that difference — and in doing so stimulate the economy.

This was the problem with the stimulus checks we received in 2008. We were handed checks for $600 or $1200, no questions asked. But the checks landed in our hands right as we were starting to worry about the economy, our jobs, the housing market, the value of the dollar — and the end of the world!

With a one-time lump-sum payment, many Americans chose to pay down debt or t0 stick the money straight into a savings account. The end result? Very little economic stimulus. And that makes sense. This time, though, our leaders are sneaking that stimulus into each of our paychecks. Piece by piece, it will land in our checking accounts. The hope is that we'll also spend the money piece by piece, boosting the economy.

Will You Spend Your Stimulus?

The economy is in worse shape than it was twelve months ago, and I wonder if that will make a difference. Last year many people sensed the storm on the horizon, so they saved. This year the thunder is rolling and the rain falling all around. Will these small, incremental payments make a difference?

No matter whether you intentionally plan to spend the government's money, or if you plan to apply it toward your saving/debt goals, you need to track where it comes from. This is the beauty of budgeting.

If you know your income is supposed to be $2,500 per month after taxes, you should be living off of that amount — or less. You should be tracking that money as it comes in. With an extra $50 per month, why not create a saving category specifically for this money? For example, you might:

  • Set up an automatic draft from your checking account to put the money in a savings account.
  • Change your direct deposit so that $50 per month goes into an account automatically.
  • Automatically add $50 every month to your highest priority debt payment.

Do what works for you. Just don't let the money come in and out of your pocket without knowing where it goes. It might stimulate the economy if you did spend it, but remember that your personal economy matters most.

J.D.'s footnote: Will you consciously do something to stimulate the economy? Why or why not? The last time I asked, most of you said, “No way! I'm saving!” But have things changed in the past few months? What's your take?

More about...Economics, Psychology

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Chris
Chris
11 years ago

I understand the goal of the stimulus funds, and also that it could be viewed as un-patriotic to save it. I was wondering if by investing those extra funds via index funds you could accomplish both goals (saving and stimulating the economy)?

DP
DP
11 years ago

We purchased a new house a week ago and since then put about 10K into the economy.. Some was local (gutters deck and a drive way done by local pros), others was not so local (supplies for the above mentioned, new furniture, a big screen TV…) So we are stimulating the economy.. But we are also doing that from cash that was saved up for that specific reason (we also paid about 5K off our debt as well). And we needed/wanted those things and COULD AFFORD THEM. We didn’t buy them just to stimulate the economy (because let’s face it,… Read more »

Ruth
Ruth
11 years ago

I’m not necessarily trying to stimulate the economy, but nor am I particularly saving more/spending less than I was before. That being said, my husband and I save a kind of ridiculous percentage of our income–20% or more. But we’re thinking of buying new couches–our dogs have destroyed our current ones, and there are good deals to be had. We are also taking advantage of travel deals, but mostly abroad…so we’re stimulating the global economy with those, but not so much the US economy. We spent last year’s stimulus checks on a trip to Europe.

Anne
Anne
11 years ago

This stimulus started during a crummy two financial months for me. So, yes, I guess I am spending it. Last month’s went to the mechanic and this month’s and next month’s will be going to the dentist. But, after that, I’m afraid it’s straight into savings to make up for my two crummy months.

Nan
Nan
11 years ago

Last year I used the stimulus money to pay off my student loans. Now we are completely debt free. This time around, the federal tax that we save will go towards increased state tax (we live in CA).

JenP
JenP
11 years ago

I’m taking every bit of extra money and putting it in savings. But I’m in kind of an odd situation. I just came across this site a few weeks ago, and I can’t stop reading it. J.D., your personal stories about your steps to finance enlightenment have been particularly inspiring. I moved across the country at the beginning of the year for a job that brings me closer to family and where my husband and I have always planned to “end up.” Unfortunately, we haven’t found work for my husband, and he’s not willing to leave his current good job… Read more »

Andy J
Andy J
11 years ago

I’ll be spending the extra money, it just won’t be right now. I am putting whatever I can into savings for a wedding (someday), a house and a car. This extra stimulus will just help me reach those goals sooner. Also, since I am earning interest with the money (though very little), I am providing the government with more tax dollars, wahoo! As for last year’s stimulus check… it’s gone. I dumped it directly into the stock market… so I stimulated those who were shorting the market! Just trying to do my part to spread the wealth around…

Templeton Editor
Templeton Editor
11 years ago

Sir John Templeton, one of the greatest investors of the twentieth century, was a great advocate of thrift. However, given our current economic crisis, this concept of whether to spend or not to spend our money (including our extra stimulus dollars) should be examined in great detail by those who best understand the economy. Next week, an event at The King’s College in New York will discuss the “Paradox of Thrift,” a term coined by John Maynard Keynes. This panel will review the concept of whether or not a revival of restrained consumerism is the only way to fix an… Read more »

Karen
Karen
11 years ago

Our extra cash will go toward paying off our house in December.

Nancy L.
Nancy L.
11 years ago

Prior to this current stimulus hitting my paycheck, I based my budget on a number slightly lower than what I usually received, by about $7/week. I did this because over the course of the year, the amount withheld would shift, and by using the lower number, I avoided having a budgeting shortfall.

I’m still creating my budget based on the lower number. I haven’t decided what I’ll do with the money over time, although I do like to have some money on hand to take care of unexpected expenses.

Ms. Clear
Ms. Clear
11 years ago

I started getting the higher amount last month. I save 10% of what I take home, so that bumped up just a bit. However, the rest is allocated to monthly expenses, which does give me a bit more wiggle room.

Gryphon
Gryphon
11 years ago

If you didn’t have any debt to put the extra money towards, maybe a money market account or a CD is the way to go with the extra fifty? I know the bank I use has an account that will let you put money into it and when it hits a point that you set it will automatically purchase a CD for you. If I recall it even gives decent interest while the money is sitting there waiting for you to build up enough, but I would need to check that and see.

Wim
Wim
11 years ago

Don’t you think that saving only 20% is what started this crisis? Anyway, what you save right now is not going to change anything, so I don’t think this question is relevant.

No Debt Plan
No Debt Plan
11 years ago

Thanks for the comments everyone. It’s my birthday today (the big 25) — hope to see you join me as readers on my blog, too. Cheers!

Matthew Brundage
Matthew Brundage
11 years ago

from the article: “No matter whether you intentionally plan to spend the government’s money…”

The author has it backwards. It’s a common fallacy to think of a tax cut as the government “giving” you something, when in reality, the government is just confiscating less of your earnings.

MarcoL
MarcoL
11 years ago

To answer the question, it will probably be spent eventually. Just formulated a budget. Going to save 20% of my income (pretax for 401k, after tax for roth). About 55% is going for all my bills. The rest will be saved in an account and spent whenever I’d like without guilt. It’s kind of the Balanced Money Formula https://www.getrichslowly.org/the-balanced-money-formula/ Except I am using 55% for needs, an eating out allowance, and monthly bills like cable internet, etc. So that will leave any excess income (such as what is coming from this tax cut) in the 25% “Wants” category which is… Read more »

No Debt Plan
No Debt Plan
11 years ago

@Matthew: I think you are splitting hairs there.

So the government is confiscating less of your earnings. Let’s say they confiscated more and then gave it back to you. What’s the difference?

Six in one, half a dozen in the other. 🙂

HollyP
HollyP
11 years ago

Yes, things have changed.

In the early fall I was planning to renovate my kitchen using cash I’d saved. As the economic news got worse I decided to wait and see how things played out.

Since then, the economic news has gotten a little better. Additionally, both my husband and I got news that strengthened our belief that our jobs are relatively secure. I’m now ready to actively start the kitche project. Upside? I’ve also saved another $5000 in the interim!

Sara
Sara
11 years ago

@No Debt Plan: Referring to it as “the government’s money” is inaccurate at best. Matthew has it right — this stimulus is simply the government not taking from certain taxpayers quite as much as it used to. Calling it “the government’s money” puts people in a much different frame of mind because (1) it sounds like we’re getting a bonus/gift, instead of simply having less seized in the first place, so it seems more expendable (as in, “it’s not really mine, so I might as well use it”), and (2) it completely fails to recognize that it’s the people’s hard… Read more »

Tyler Karaszewski
Tyler Karaszewski
11 years ago

I doubt this even affects me — the one last year didn’t, and I never got a stimulus check. I will never spend money for the sole purpose of stimulating the economy. The basic premise of the economy is this: The more work we do, the more we can consume. The more we consume, the more work we allow others to do (to create the things that we consume). The more work that others do, the more that they can consume. Etc. I’d rather the economy find a way to give people more leisure time while encouraging less consumption. It… Read more »

E
E
11 years ago

I just opened an emergency savings account with my tax refund; this extra money, plus a bit more, will likely go there. So no new spending, but more $ available for my bank to lend and more tax $ on the interest I earn.
Win-win, I think. 🙂

Regina
Regina
11 years ago

@No Debt Plan: Matthew is not splitting hairs, it’s a an important difference. It is not the government’s money, the government did nothing to earn it. It is your money taken from you by force.

Also, it is not the same thing if the government takes more and gives it back later than if they take less. The first is called a FREE LOAN. I don’t know about you, but I’d rather be making interest on that money than just handing it over to the government so they can gift back to me what was mine in the first place.

No Debt Plan
No Debt Plan
11 years ago

@Sara: I still disagree. 🙂 Yes, the government did not generate the money. The government taxed us and took that money from us. I’m not saying it is necessarily a gift, but in a way it kind of is. The law that is on the books currently, the law of the land you live in, says X dollars of tax are taken out for every Y dollar you earn. The fact that they are taking out less doesn’t make it any less of a law that is currently in place. Do I agree with the law? No. But to say… Read more »

nonskanse
nonskanse
11 years ago

Hmm… I put my “leftover” money in a direct deposit to savings for each paycheck. I probably won’t notice the extra except as a little extra ING money. Guess i’m selfish!

J.D.
J.D.
11 years ago

Happy birthday, Kevin! And thanks for the guest post. Gives me a chance to finish moving my office up the street. 🙂

Kira
Kira
11 years ago

I think that we’ll probably end up spending at least some of it, hopefully on local foods as the spring season begins. As long as the money goes towards quality items, I don’t have a problem using it rather than saving it. Which of course isn’t to say that I would spend just to spend.

Tim
Tim
11 years ago

i don’t get it. even if you save or you pay off debt, you are stimulating the economy, so the last round did have an affect. we haven’t been doing anything differently during this economic situation. well, maybe we have. i think we have been spending a little more because of some of the deals out there. we have definitely spend some money the past 6 months from new living room furniture, to a new bed, to a new computer, to a new watch, to new clothes, etc. all of it has been within our budgeting goals, though, so nothing… Read more »

jtimberman
jtimberman
11 years ago

The extra money we get through this “stimulus,” tax refunds, bonus pay, etc, get applied directly to where we’re at in Dave Ramsey’s baby steps.

Harley Pebley
Harley Pebley
11 years ago

Be careful with those withholding table changes. Just because less is coming out doesn’t mean the taxes due at the end of the year are less. I had to increase my withholdings to offset the table adjustments so I don’t end up owing next year.

TR
TR
11 years ago

Well, we have our first baby on the way, so I think any extra we get will go to getting the baby stuff we need. We’ll look for bargains and hand-me-downs but some stuff we definitely will get new, like the car seats.

Will
Will
11 years ago

I haven’t seen this opinion expressed yet, so it may be unpopular: I don’t believe that we should equate spending with patriotism. If consumer spending rebounds and “saves” the economy, I will be disappointed. Why? Simple: The chickens are coming home to roost. We as a nation have been living for the now, spending beyond our means, and chasing the hollow promise that owning just one more thing will make us happy. If the recession reverses on a wave of consumerism, that won’t fix the gargantuan trade deficit that is slowly ruining our currency and national credit. We as a… Read more »

The Personal Finance Playbook
The Personal Finance Playbook
11 years ago

Marginal propensity to consume is a term coined by John Maynard Keynes. My post for the day is about him, too.

Pepper
Pepper
11 years ago

I plan to donate at least some of it to animal shelters and other nonprofits, which are in dire straits right now. This is not really stimulating the economy, but helping to cushion the effects of the meltdown. My income will definitely be down this year, but thanks to years of diligent savings and getting used to living below my means, I’ll be okay.

Sulana
Sulana
11 years ago

Harley Pebley has it right; it’s the WITHHOLDING that is being changed, not the amount due next April. All of this ‘extra’ money that we’re currently seeing in our paychecks is going to have to go right back to the government next tax year. The IRS website (irs.gov) has a wonderful Witholding Calculator (link: http://www.irs.gov/individuals/article/0,,id=96196,00.html) that will help you see exactly how much you will owe in taxes next year. My extra $30 per paycheck is going straight into a savings account. This way, I get to keep the interest myself and will have the money available to pay the… Read more »

Miss Music
Miss Music
11 years ago

This is not last year’s stimulus divided up over the year instead of a lump sum. Harley Pebley is absolutely correct. All they changed is the withholding tables. They didn’t change the tax rates. They are letting you keep a little more of your money now, and you may end up having to give it back at tax time.

Michelle
Michelle
11 years ago

For a long term strong economy, would it make sense for us ALL to get out of debt?

For short term economy strength, would it make sense for us to spend?

I vote for long term strength.

lizriz
lizriz
11 years ago

I’m under a 15% paycut, spending A LOT less than before. Very frustrated. H/R actually sent out an email about increasing your investment in your 401K – I changed my contribution to 0% when we got the pay cut. So I just about cried when the increase came. It’s only $32/month take home for me. As much as like to just absorb and use it, then it’s gonna hurt when it goes away, so I’ve set up an automatic transfer to my savings to save it. I need more savings, so that’s a good thing for me, and when it… Read more »

Do You Dave Ramsey?
Do You Dave Ramsey?
11 years ago

Very interesting material Kevin. I find that I view this very differently based on which economic hat I’m wearing – my micro hat or my macro hat. I’m a firm believer in the accountability of the individual so I’ll start mirco… in this vision I can allow myself to view this new plan as sinister, as if they are trying to trick me. But I also have to agree that it’s ‘extra money’ (my money really) and that I am accountable for how I treat it. In this world I’m pleased that I run a zero-based budget so I’ll surely… Read more »

Sharon
Sharon
11 years ago

I recently changed my IRA contribution from 5% to 10% and I was thinking about changing it to 15% which is my limit. I will probably do that because of the extra money. I just paid my house off, so I already have the “breathing space” to do that.

Allison
Allison
11 years ago

Our grocery bill has gone up on avg about $100 per month this year as we’ve shifted from a diet of primarily prepackaged/processed foods to buying from local & organic producers/farmers markets wherever possible & supplementing with some items from Trader Joe’s & Whole Foods. The extra $50 each for my husband & I will leave us some room in our budget to continue spending on this food that has made us feel so much healthier and energized. Without the stimulus, we would have to cut back right now on something else in the budget to offset. I like the… Read more »

Kevin
Kevin
11 years ago

To comment on the whole government stimulus/they-shouldn’t-tax-so-much discussion, I think it is interesting that income tax is pretty much taken for granted in our country despite its relatively recent pedigree.

It does seem necessary since we do expect government to do so much for us (Social Security, justice system, military, etc.), but there is certainly an argument for saying that there simply isn’t a good thing. I don’t know, I can kind of see it both ways.

Sarah
Sarah
11 years ago

It’s going straight into savings. I didn’t want to get used to extra money and then miss it when the stimulus is finished.

I gave last year’s stimulus to my brother for college tuition – guess what he did with it – that’s right he saved it. 🙂

Cynthia
Cynthia
11 years ago

Has anyone read or read about the book “Nudge”? I think that this idea is, at least, very similar to ones it discusses. One of the authors is a current advisor to the President and was also one during the campaign. Both are University of Chicago professors who research how to “Nudge” people to make decisions that are thought to improve health, wealth or overall well being. The website is http://www.nudges.org/index.cfm

racy
racy
11 years ago

We didn’t quality for any stimulus check earlier. I noticed an extra $10 in my paycheck this morning though. By this afternoon my automatic investment in my personal bond fund was increased. I’ve done this for years: every time I get an increase in pay, I put some or all of it in savings/investments. ..guess that’s why I didn’t qualify for that stimulus check. :`)

icup
icup
11 years ago

Meh. Patriotism is the refuge of the scoundrel. The rest of the country did its level best to try to screw me over in the last 2 decades by ruining the economy, so why should I help them out now by trying to ‘fix’ it? Let’s see. Cheaper goods. Cheaper travel. Increased wages for me. Recession proof job. Recession proof real estate market in my town. So far I am not seeing any downside to this recession. I’ll save mine just to spite the bankers. In fact, I think I’ll save it in a jar under my mattress, just so… Read more »

Steven@HundredGoals.com
11 years ago

My last stimulus check helped for me to afford a trip to Argentina. This time around the money will likely end up in a savings account to be spent at a later date. I don’t have any direct plans of spending it on anything in particular. It would be nice if we were able to get a lump sum payment so that it wouldn’t simply slip through our fingers, but that is the plan…those evil government people… 😉

chris
chris
11 years ago

Sorry to disappoint the lawmakers, but I can’t be tricked into spending more by the old “a few extra bucks in the paycheck” trick. I have my bi-weekly pay direct deposited into my savings account. I have a monthly spending plan, and each month I transfer the planned amount to my checking. Anything that is not part of the plan requires a conscious decision and an additional transfer from savings. So if my paycheck is increased by a few bucks, all that will happen is my savings balance will increase a bit faster – unless I actually decide to spend… Read more »

JerichoHill
JerichoHill
11 years ago

Umm, the personal savings rate doesnt not include 401Ks or pretax savings plans, fyi.

Further, the MPC varies across income groups. MPC is generally inversely related to one’s income grouping.

Egaas
Egaas
11 years ago

I personally jacked up my 401K contributions 1%, which just about evened out.

Leslie
Leslie
11 years ago

I don’t plan to do anything with the money. I intend to adjust my withholding allowances to put the amount back to where it was, because I sure don’t see much possibility of my taxes going down.

Right now I set my allowances so that I come as close to breaking even as I can. Why give the government an interest free loan for a year, which is all a refund is? If they take less out of my paycheck, I’ll just get hit with a big tax bill next spring.

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