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Liquidity Constraints and Intertemporal Consumer Optimization: Theory and Evidence from Durable Goods

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  • Chah, Eun Young
  • Ramey, Valerie A
  • Starr, Ross M

Abstract

This paper develops and tests the implications of optimal consumption behavior with borrowing constraints. The theory shows that liquidity constraints imply a distinctive intertemporal relationship between durable and nondurable goods consumption. Binding liquidity constraints appear as part of an error correction term derived from the long-run cointegrating relationship between durables and nondurables. When liquidity constraints are binding, the error correction term will have predictive power for the future change in nondurable consumption. Empirical tests of the implications using aggregate data support the hypothesis that liquidity constraints, rather than rule-of-thumb behavior, best explain the excess sensitivity of consumption to predictable changes in income. Copyright 1995 by Ohio State University Press.

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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 27 (1995)
Issue (Month): 1 (February)
Pages: 272-87

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Handle: RePEc:mcb:jmoncb:v:27:y:1995:i:1:p:272-87

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. repec:fth:coluec:465 is not listed on IDEAS
  2. Ben S. Bernanke, 1982. "Adjustment Costs, Durables, and Aggregate Consumption," NBER Working Papers 1038, National Bureau of Economic Research, Inc.
  3. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-57, April.
  4. Marjorie Flavin, 1985. "Excess Sensitivity of Consumption to Current Income: Liquidity Constraints or Myopia?," Canadian Journal of Economics, Canadian Economics Association, vol. 18(1), pages 117-36, February.
  5. Fumio Hayashi, 1985. "Tests for Liquidity Constraints: A Critical Survey," NBER Working Papers 1720, National Bureau of Economic Research, Inc.
  6. Robert E. Hall & Frederic S. Mishkin, 1980. "The Sensitivity of Consumption to Transitory Income: Estimates from Panel Data on Households," NBER Working Papers 0505, National Bureau of Economic Research, Inc.
  7. Wilcox, David W, 1989. "Social Security Benefits, Consumption Expenditure, and the Life Cycle Hypothesis," Journal of Political Economy, University of Chicago Press, vol. 97(2), pages 288-304, April.
  8. Caballero, Ricardo J, 1993. "Durable Goods: An Explanation for Their Slow Adjustment," Journal of Political Economy, University of Chicago Press, vol. 101(2), pages 351-84, April.
  9. Marjorie A. Flavin, 1991. "The Joint Consumption/Asset Demand Decision: A Case Study in Robust Estimation," NBER Working Papers 3802, National Bureau of Economic Research, Inc.
  10. Stephen P. Zeldes, . "Consumption and Liquidity Constraints: An Empirical Investigation," Rodney L. White Center for Financial Research Working Papers 16-88, Wharton School Rodney L. White Center for Financial Research.
  11. Bertola, G. & Caballero, R.J., 1990. "Kinked Adjustment Costs And Aggregate Dynamics," Discussion Papers 1990_20, Columbia University, Department of Economics.
  12. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  13. Flavin, Marjorie A, 1981. "The Adjustment of Consumption to Changing Expectations about Future Income," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 974-1009, October.
  14. repec:fth:harver:1435 is not listed on IDEAS
  15. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
  16. Runkle, David E., 1991. "Liquidity constraints and the permanent-income hypothesis : Evidence from panel data," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 73-98, February.
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