Does ‘free money’ really boost spending?

Everybody loves free money, especially getting money back from the Government. We all wish there were helicopter drops of free money on a regular basis. However, in reality we only get free money very rarely.

So, the interesting question is what we do with this free money. Do we spend it or save it? If we do spend it, then is this an effective way to boost economic growth?

In one example, Singapore’s Ministry of Finance announced in February 2011 that, as an attempt to share the nation’s economic growth from 2010, the Government would distribute a one-time payout of Growth Dividends to all adult Singaporeans over 21 years old.

The amount each Singaporean would receive depended on their wealth, with on average 80 per cent of all Singaporeans receiving between S$500 and S$700 in Growth Dividends.

The package was designed to share the budget surplus and, especially, provide relief to the lower- and middle-income Singaporeans in their spending needs.

Economic theory suggests that if you give households free money (what we call an “income shock”), they will not necessarily spend the money but most likely save it. In surveys, people also say they will save the money or use it to pay down debt. Human nature dictates that, in survey responses, you want to appear more responsible and claim you will save or pay down debt.

But in reality, if you “follow the money” through their credit and debit card spending as well as credit card debt, you find that they are more likely to spend it.

CHARGE THE EXPENSE

In a paper, my colleague Wenlan Qian and I looked at the spending and debt response to the Growth Dividend package. We used a representative sample of more than 180,000 consumers in Singapore and studied how their spending behaviour on their credit card, debit card and bank chequing accounts responded to this positive income shock.

We had a number of interesting findings. First, consumers’ consumption rose significantly after the announcement: For each dollar received, consumers on average spent 90 cents (aggregated across different financial accounts) during the 10 months after announcement. On the other hand, consumers’ credit card debt experienced a moderate decrease.

Second, we found a strong “announcement” effect; consumers started to increase spending during the two-month announcement period before the cash payout.

Third, consumption response was concentrated in debit and credit card spending. Fourth, we did not find any significant change in the number of debit transactions for chequing accounts as captured by ATM usage, branch and online transactions. This suggests the majority of spending happened through credit and debit card spending.

WHO SPENT MORE

Lastly, consumption response varied across spending categories and individuals. Consumption rose primarily in the non-food, discretionary category and for low-income households. Young, unmarried, non-college-educated and likely liquidity-constrained consumers relied more on debit card spending in their consumption response.

Low-income consumers reacted strongly to the stimulus programme in spending. They spent 20 cents per dollar received on their debit card and 61 cents per dollar received on their credit cards. The high-income consumers, on the other hand, did not spend at all.

Separating the response by ethnicity, we found that Chinese Singaporeans significantly increased their spending on both types of cards while Indian Singaporeans saved the Growth Dividend payments.

Our results have implications for future policy actions of the Government in Singapore and elsewhere. Is this a good way for the Government to use the surplus? The economist in me says taxpayers should get back surplus whenever possible, as I believe governments are involved in wasteful spending.

But who should receive this money is important. Our results show that, as expected, low-income households did spend the money and the high-income households saved the money. In future, the Government could gear such stimulus programmes more towards low-income households.

ABOUT THE AUTHOR:

Sumit Agarwal is Associate Professor of Finance at the NUS Business School. This is abridged from an article first published on the school’s Think Business portal.