Rüdiger Bachmann, Benjamin Born, Olga Goldfayn-Frank, Georgi Kocharakov, Ralph Luetticke, Michael Weber 20 November 2021
Monetary policy is often the preferred tool to stabilise business cycles because it can be implemented swiftly and it does not rely on large fiscal multipliers. When the effective lower bound (ELB) on nominal interest rates limits the ammunition of conventional monetary policy, however, alternative measures are needed. Unconventional fiscal policy uses changes in consumption taxes to engineer an increasing path of future prices of consumption goods, either through pre-announced increases or immediate, temporary cuts. With nominal interest rates fixed at the ELB, unconventional fiscal policy acts as a potential stimulus because higher expected future prices are tantamount to lower current real interest rates, which should incentivise spending today. The theoretical channel through which unconventional fiscal policy stimulates aggregate demand is, hence, very similar to the transmission channel of conventional monetary policy and operates through the consumption Euler equation (Correia et al. 2013, D’Acunto et al. 2018, 2021a, 2021b).
In a recent paper (Bachmann et al. 2021b), we exploit the unexpected announcement of the German federal government on 3 June 2020 to temporarily cut the regular value added tax (VAT) rate by 3 percentage points with the aim of studying the effectiveness and transmission channels of unconventional fiscal policy. The announcement was passed into law on 29 June 2020, became effective a few days later on 1 July 2020, and lasted until 31 December 2020. Using survey methods and scanner data, we find that Germans substantially increased their consumption expenditures, especially on durable goods, during the period of lower VAT.
In principle, changes in the VAT rate affect all consumers in an economy. Therefore, identifying their causal effect on consumption is difficult. In addition, during the second half of 2020, Germany was in the midst of the Covid-19 pandemic and an accompanying recession. The stated purpose of the temporary VAT cut was, therefore, to stimulate the German economy. It was part of a larger stimulus package which also included, for instance, a direct transfer payment for families with children and a number of tax relief measures for firms. Finally, the second half of any year exhibits particular seasonal spending patterns (e.g. summer vacations and Christmas). To tackle these empirical challenges, we employ survey methods, using existing survey infrastructures at the Bundesbank and the Gesellschaft für Konsumforschung (GfK), a research institute that produces the German part of the EU-harmonised consumer sentiment index. We do so with an ex-ante and an ex-post approach.
In July 2020, we elicited qualitative spending plans for durables for the second half of 2020 and the level of informedness about the change in VAT. Most consumers knew about the cut in VAT but only a subset of them knew about the return to normal rates in January 2021 (see Figure 1, panel B). Importantly, consumers planning to increase their durable consumption spending in the second half of 2020 for reasons unrelated to prices (e.g. long-standing spending plans) are no better informed about the full VAT path than those that report price changes as a reason for higher spending. These patterns make a reverse causality story – from planned shopping activity regardless of reason to better informedness about the VAT policy – unlikely. Panel A of Figure 2 shows that, more generally, consumers that plan to buy more durables, do so often for price-related reasons. Child-related transfers, by contrast, play only a small role.
Figure 1 The ex-ante approach
A) Reasons for increased durable spending plans
B) Indentification: Informedness
Notes: Panel A: After the respondents answered the question about their durable spending plans, those that answered with an increase were asked about their reasons for planning to do so. They were given eight reasons which they could evaluate on a four-point intensity scale. Panel shows the fractions of respondents that chose the highest two answers on this intensity scale. Panel B, left-hand side shows fraction of respondents that were informed about the full VAT path. Panel B, right-hand side shows share of fully informed for those survey respondents that plan to increase their durable consumption spending in the second half of 2020, split into those that self-report price changes and those that give other reasons. See paper for details.
To establish our first main result, we split survey participants into those that were informed about the complete VAT path and others. Our argument is that only the former group has scope for an intertemporal substitution motive, while the latter group perceives, at best, an income effect. Comparing the spending plans of the two groups therefore allows us to identify, along the extensive margin, a lower bound for the intertemporal substitution effect of the VAT policy on planned durable spending.
We find the existence of statistically and economically significant VAT-induced intertemporal substitution in durable expenditures. Specifically, the VAT policy makes households about 10 percentage points more likely to increase durable purchases relative to the second half of a normal year. By splitting our results along inflation expectations, we provide additional evidence that consumers engage in intertemporal substitution.
In January of 2021, we asked survey participants about their realised durable consumption spending in euros during the second half of 2020. We supplement the survey data for durables with scanner data from GfK, which cover euro spending on semi-durables and non-durables. We achieve identification by separating survey respondents according to their retrospectively perceived pass-through of the VAT cut to consumer prices (Figure 2) (see Montag Sagimuldina and Schnitzer 2020 for a documentation of pass-through for gasoline). Again, we rule out reverse causality by showing that perceived pass-through is the same for households that shop around looking for bargains and those that do not.
Figure 2 The ex-post approach. Identification: perceived pass-through
Notes: Figure shows the distribution of perceived VAT pass-through (left panel), the fraction of respondents which perceive a pass-through of equal to or larger than 1 percent (middle panel), and their average perceived pass-through (right panel) by being a bargain hunter or not from the January 2021 Bundesbank Online Panel – Household survey. See paper for details.
Consumers who do not perceive that after-tax prices changed have again no motive to act on the VAT policy. Therefore, by comparing the spending behaviour of consumer groups with different levels of perceived VAT pass-through, we can identify the causal effect of the VAT policy on consumption spending.
We find that the temporary VAT cut led to a substantial relative increase in durable spending. According to our preferred estimate, households with a high perceived pass-through spent about 36% more than those with low or no perceived pass-through. Similarly, we find that semi- and non-durable spending was higher for households that perceived a high pass-through relative to other households by about 11% and 2%, respectively. That is, the VAT policy effect is increasing in the durability of the consumption good, consistent with a simple Euler-equation argument. We also find that the VAT policy effect, in particular for more durable goods, increases over time and is maximal right before the reversal of the VAT rate (Figure 3) (see McKay and Wieland 2021b for similar effects from monetary policy). In a back-of-the-envelope calculation, these micro estimates translate into an aggregate effect of €21 billion of additional durable spending and of €34 billion of overall consumption spending due to the temporary VAT cut.
Figure 3 Time path of spending response
Notes: Results based on OLS regressions using GfK scanner data. The OLS regressions have been pooled over two-month windows. The left-hand-side spending data on, respectively, semi-durables and non-durables have been transformed with the inverse hyperbolic sine transformation. We code any answer with “perceived pass-through of ≤ 0%” as 0, and > 0% as 1 in the GfK data. Controls include gender, age, education, employment status, having children, the households’ income level, and net wealth, as well as controls for the federal state and the municipality size the household lives in.
In the cross-section of consumers, we find that two not necessarily overlapping groups of consumers drive the durable spending response: (1) bargain hunters – i.e households that self-report that they shop around or households that, in a survey experiment, turn out to be particularly price-sensitive; and (2) younger households in a relatively weak financial situation. We also find no evidence that perceived credit constraints of households or local previous exposure to Covid-19 matter. Finally, the stabilisation success of the temporary VAT cut is also related to its simplicity (Andre et al. 2021, D’Acunto et al. 2021). Its effect is not concentrated in households that are particularly financially literate or have long planning horizons for saving and consumption decisions. Hence, in contrast to unconventional monetary policy which often relies on consumer sophistication (e.g. Farhi and Werning 2019, Gabaix 2020, Woodford 2019 for the case of forward guidance), unconventional fiscal policy is successful in stimulating aggregate consumption spending because of its simplicity and salience, consistent with the theoretical and empirical arguments in Bianchi-Vimercati et al. (2021) and D’Acunto et al. (2021a). Taken together, these findings suggest that the temporary VAT cut not only had a positive stabilisation effect but also positive distributional implications consistent with the idea that a VAT cut works in a progressive way.
The unexpected, temporary VAT cut in Germany in the second half of 2020 worked as a measure of unconventional fiscal policy. We show that the policy stimulated spending on durables and, to a lesser extent, on semi-durable and on non-durable consumption goods. From a distributional perspective, the temporary VAT cut worked in a progressive way. Young, low-net-wealth households reacted the most. This reaction did not depend on measures of financial literacy and saving discipline. We do not take a stance on the optimality or even the appropriateness of this policy measure. We do show, however, that, as suggested by Correia et al. (2013), an unexpected temporary VAT cut operates indeed like conventional monetary policy and can be an effective stabilisation tool when the ELB binds.
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