Chen Lian (UCB)

Abstract:

We study the psychological costs of financial constraints and their economic consequences. Using a US-based representative survey, we document that the majority of US households experience financial stress and that the stress drains valuable cognitive resources and time from productive work. We incorporate financial stress into an otherwise standard intertemporal decision model. We find that the empirically large share of stressed households indicates naivete because sophisticated households who understand the economic consequences of financial stress would instead save out of high-stress states. Since relieving financial stress increases productive working hours, financial stress reverses the counterfactual negative wealth effect of labor supply. Lump-sum fiscal transfers relieve financial stress, increase labor supply, and boost aggregate output. This channel provides a new rationale for using stimulus payment to boost liquidity and stimulate the economy.