The Propensity to Borrow out of Expected Permanent Income

Abstract

One prediction of the Permanent Income Hypothesis is that households who are illiquid may wish to borrow against future income when there is a positive shock to their future income process. We informally model this prediction in a two-period setting and then test it using Equifax data. We demonstrate that Democrats experience a strong, positive shock to their expectations about their future real income around the 2020 presidential election. Our difference-in-difference analysis finds that in response Democrats were 0.08% more likely to take on debt in order to buy a car, and that their outstanding auto loan balance increased by $104 on average. Compared to the rate at which Democrats purchased cars via loan prior to the election, this 0.08% increase represents a 1.37% increase in the purchase rate. We validate our results by finding a similar result holds for installment loan purchases. We show that this result is robust to our empirical assumptions.