Consumer Debt is 130% of Income: Avoiding Budget Constraint Orthodoxy

Abstract:     
Consumer theory maximizes utility subject to a budget constraint, ignoring that the ratio of consumer debt to disposable income has varied between 30% and 130%. Granger-causality tests also confirm Consumption-precedence over income. We discuss features of newer US data allowing families greater control on the timing and level of income. Our 'target-seeking' Wiener-Hopf-Whittle optimization yields a two-equation system where both consumption and income are endogenous, similar to quantities and prices in a demand system. We resolve five old 'puzzles' from the consumer theory literature and provide estimates of shadow prices of the income level and adjustment costs.

Number of Pages in PDF File: 22

Keywords: Stochastic dynamic optimum, Target seeking, VAR, Wiener-Hopf Optimization, Causality Testing, Habit

JEL Classification: E21, E63

Accepted Paper Series