Household Finance

A Functional Approach

Sumit Agarwal, Wenlan Qian, Ruth Tan

• Publisher: Palgrave Macmillan
• Year: 2020
• Print ISBN:
  9789811555251
• eBook ISBN:
  9789811555268
• Topic: Business
• Subtopic: Finance
• Index: Business

Household finance studies is a relatively recent field, exploring a growing understanding of how households make financial decisions relating to the functions of consumption, payment, risk management, borrowing and investing; how institutions provide goods and services to satisfy these financial functions of households; and how interventions by firms, governments and other parties affect the provision of financial services. This timely book analyses existing findings about household behavior as well as findings related to policy interventions.

With international case studies, this book reviews a topic of global importance and brings a crucial up-to-date survey of the field for researchers and postgraduate students.

© The Author(s) 2020

S. Agarwal et al.Household Financehttps://doi.org/10.1007/978-981-15-5526-8_1

Begin Abstract

1. Introduction

Sumit Agarwal¹ , Wenlan Qian¹ and Ruth Tan¹

(1)

National University of Singapore, Singapore, Singapore

Sumit Agarwal (Corresponding author)

Email: [email protected]

Wenlan Qian

Email: [email protected]

Ruth Tan

Email: [email protected]

Keywords

BorrowingConsumptionFinancial functionsInvestmentPaymentSaving

End Abstract

The study of Household Finance encompasses the topics of (1) how households make financial decisions relating to the functions of saving, consumption, investment, housing, payment, borrowing and risk management, (2) how organizations provide goods and services to satisfy these financial functions and (3) how interventions by firms, governments and other parties affect the provision of financial services. This functional definition shows that household finance is a substantial component of the financial sector.

This approach of reviewing the field of household finance, as opposed to a product or institutional approach, allows us to have a household-oriented focus. For example, households who want to save, consume, invest, pay, borrow and manage risk will likely look across a variety of products, various formal and informal institutions as well as the legal frameworks within which contractual relationships can be enforced.

The scope of household finance spans multidisciplines, embracing not just finance and economics but also industrial organization (e.g., automatic enrolment in workplace saving plan), law (e.g., regulation of retail financial transactions), psychology (e.g., decisions affected by framing and cognitive biases) and sociology (e.g., decisions shaped by social networks).

A better understanding of household finance can help to improve household decision making through better financial products, supervision and regulation and avoid problems such as inadequate retirement planning, over-leveraging, uninformative sales tactics and poorly designed products.

This book is divided into nine chapters comprising (1) Introduction and the seven functions of (2) Saving, (3) Consumption, (4) Investment, (5) Housing, (6) Payment, (7) Borrowing and (8) Risk Management, as well as a concluding chapter on (9) Financial Inclusion and Financial Technology. Below is a short description of each of the chapters.

1 Saving

The saving function enables households to smooth their consumption so that they can have a reasonable standard of living during retirement, have funds to get through tough times and leave bequests if they so desire.

Under the inter-temporal substitution motive and life cycle motive, households smooth their consumption by borrowing when they have insufficient funds and saving when they have excess to sustain their consumption in their later years (Keynes 1936; Katona 1975; Sturm 1983; Fisher and Anong 2012; Lee and Hanna 2015).

In the presence of uncertainty regarding employment, healthcare expenses and liquidity constraints, the precautionary motive of saving kicks in (Deaton 1991; Hubbard et al. 1995; Browning and Lusardi 1996).

There is some overlap between the precautionary motive and the bequest motive. If money set aside for contingencies is not depleted, what is left naturally becomes bequests (Dynan et al. 2002). The evidence that the elderly do not dissave as quickly as expected is also consistent with the bequest motive (Kotlikoff 1988; Browning and Lusardi 1996; Coleman 1998; Chamon and Prasad 2010). In Japan, the high cost of housing gives rise to a phenomenon where the elderly move in with their children and are cared for by them in return for a bequest upon their demise (Horioka 1984; Ando and Kennickell 1987; Shibuya 1987).

The decision to save is affected by various factors. A change in the interest rate and a change in the inflation can affect household saving through the income effect and the substitution effect (Weber 1975; Friend and Hasbrouck 1983; Shibuya 1987; Wright 1969; Boskin 1978; Gylfason 1981; Tullio and Contesso 1986; Howard 1978; Shinohara 1982; Grigoli et al. 2018) .

If markets are perfect, corporate saving can substitute for personal saving (Montgomery 1986; Grigoli et al. 2018; Feldstein 1973).

Demographic factors such as age (Hayhoe et al. 2012; Grigoli et al. 2018), ethnicity, household composition (Rha et al. 2006; Yuh and Hanna 2010; Browning and Lusardi 1996; Attanasio 1998; Denizer et al. 2002), employment (Yuh and Hanna 2010), education status (Yuh and Hanna 2010; Fisher and Montalto 2010) and health status (Yuh and Hanna 2010; Fisher and Montalto 2010; Heckman and Hanna 2015) also affect saving behavior.

In addition, socio-economic factors such as productivity growth (Kapteyn et al. 2005), income level (Avery and Kennickell 1991; Chang and Huston 1995; Rha et al. 2006; Yuh and Hanna 2010; Henager and Mauldin 2015; Grigoli et al. 2018), credit availability (Shinohara 1982) and financial literacy (Lusardi and Mitchell 2007; Agarwal et al. 2009a; Agarwal et al. 2011a; Lusardi and Mitchell 2014) also play a role in how households approach saving decisions.

Finally, the government can use incentives such as tax deferral, tax exemptions and long-term saving plans to encourage saving among the people so that there will be less need for social support later (Carroll and Summers 1987; Tanzi and Zee 2000; Duflo et al. 2006; Sommer and Sullivan 2018).

2 Consumption

The consumption function examines how consumption is affected by anticipated and unanticipated changes in income under the Keynesian model, permanent income model and life cycle model. The way that consumption responds to changes in income has important implications for macroeconomic stabilization policies, both fiscal and monetary.

Economists embrace the view that households save and borrow to smooth consumption over their life cycle. However, this notion of smoothing is challenged by imperfections such as liquidity constraints.

Studies have shown that the drop in consumption around retirement is larger for households with lower income replacement rate from social security and their pensions (Bernheim et al. 2001), that the consumption of food stamp beneficiaries rise on receipt of payment and decline until the next payment (Stephen Jr 2003; Mastrobuoni and Weinberg 2009), that households cut consumption when they reach the predictable end of their eligibility for unemployment benefits (Ganong and Noel 2019) and that the average caloric intake drops at retirement (Stephens Jr and Toohey 2018).

Access to better loan terms appears to stimulate consumption. Brady et al. (2000), Canner et al. (2002) and Greenspan and Kennedy (2008) find that homeowners who refinance their mortgages on more favorable terms spend more.

Income shocks can affect consumption spending. Agarwal and Qian (2014) study consumption response to a one-time cash payment to Singaporeans. They find that consumers with low liquid assets or with low credit card limit experienced stronger consumption responses. Di Maggio et al. (2017) examine unanticipated income changes using US home mortgages subject to a mortgage rate reset. They find that households who are more constrained tend to be more responsive to positive income shocks.

Studies find that predictable income streams can cause changes in spending behavior too. Stephens Jr (2008) examines consumption reaction following the final payment of a vehicle loan and observes that an increase in discretionary income leads to an increase in non-durable consumption. In an earlier paper, Stephens J...

Table of contents

• Cover
• Front Matter
• 1. Introduction
• 2. Saving
• 3. Consumption
• 4. Investment
• 5. Housing
• 6. Payment
• 7. Borrowing
• 8. Risk Management
• 9. Financial Inclusion and Financial Technology
• Back Matter