The Economics of Financial Stress
We study the psychological costs of financial constraints and their economic consequences. Using a representative survey of U.S. households, we document the prevalence of financial stress in U.S. households and a strong relationship between financial stress and measures of financial constraints. We incorporate financial stress into an otherwise standard dynamic model of consumption and labor supply. We emphasize two key results. First, a psychology-based theory of poverty traps requires two equally important components: financial stress itself and naivete about financial stress. Specifically, sophisticates save enough to escape high-stress states, because they understand that doing so alleviates the economic consequences of financial stress. On the other hand, naifs dis-save, fall into a poverty trap, and incur high welfare losses. Second, the financial stress channel can reverse the counterfactual negative wealth effect on labor supply because relieving stress frees up cognitive resources for productive work. Financial stress also has macroeconomic implications on wealth inequality and fiscal multipliers.
For helpful comments and suggestions, we are grateful to Marios Angeletos, Abhijit Banerjee, Nicholas Barberis, David Berger, Tito Boeri, Leonardo Bursztyn, James Choi, Stefano Dellavigna, Eliana La Ferrara, Pierre-Olivier Gourinchas, Joel Flynn, Jonathon Hazell, Supreet Kaur, Yueran Ma, Anandi Mani, Gonzalo Maturana, Peter Maxted, Tim Mcquade, Sendhil Mullainathan, Emi Nakamura, Gautam Rao, Dmitry Taubinsky, Neil Thakral (discussant), Ricardo Perez-Truglia, Gautam Rao, Christopher Roth, Karthik Sastry, Jon Steinsson, Frank Schilbach, Benjamin Schoefer, and seminar participants at Behavioral Economics Annual Meeting, NBER Behavioral Finance Meeting, Bocconi, Miami Behavioral Finance Conference, TSE, Stanford, SED, UC Berkeley, UC Davis, Biennial Consumer Finance and Macroeconomics Conference, Psychology and Economics of Poverty Annual Convening, and the 16th CSEF-IGIER Symposium on Economics and Institutions. The survey was approved by UC Berkeley IRB 2021-11-14868. We thank Zhuoran Lyu, Jack Mannion, Emily Martell, Bruno Smaniotto, and Laura Waring for excellent research assistance and the BB90 fund for financial support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Gorodnichenko thanks BB90 fund for financial support.