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?

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Related Articles at Get Rich Slowly:

• Calculate Your Economic Stimulus Tax Rebate
• How Marginal Tax Rates Work
• Daily Links: Great Comments Edition
• Some Thoughts on the Stock Market, the Federal Funds Rate, and Economic Stimulus
• Daily Links: Blind Money, Check Fraud, and Economic Stimulus

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