Saving and Liquidity Constraints

44 Pages Posted: 29 Jun 2004 Last revised: 28 Sep 2010

See all articles by Angus Deaton

Angus Deaton

Princeton University; National Bureau of Economic Research (NBER)

Date Written: December 1989

Abstract

This paper is concerned with the theory of saving when consumers are not permitted to borrow, and with the ability of such a theory to account for some of the stylized facts of saving behavior. When consumers are relatively impatient, and when labor income is independently and identically distributed over time, assets act like a buffer stock, protecting consumption against bad draws of income. The precautionary demand for saving interacts with the borrowing constraints to provide a motive for holding assets. If the income process is positively autocorrelated, but stationary, assets are still used to buffer consumption, but do so less effectively, and at a greater cost in terms of foregone consumption. In the limit, when labor income is a random walk, it is optimal for impatient liquidity constrained consumers simply to consume their incomes. As a consequence, a liquidity constrained representative agent cannot generate aggregate U.S. saving behavior if that agent receives aggregate labor income. Either there is no saving, when income is a random walk, or saving is contracyclical over the business cycle, when income changes are positively autocorrelated. However, in reality, microeconomic income processes do not resemble their average, and it is possible to construct a model of microeconomic saving under liquidity constraints which, at the aggregate level, reproduces many of the stylized facts in the actual data. While it is clear that many households are not liquidity constrained, and do not behave as described here, the models presented in the paper seem to account for important aspects of reality that are not explained by traditional life-cycle models.

Suggested Citation

Deaton, Angus S., Saving and Liquidity Constraints (December 1989). NBER Working Paper No. w3196, Available at SSRN: https://ssrn.com/abstract=227299

Angus S. Deaton (Contact Author)

Princeton University ( email )

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