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Liquidity Constraints and Precautionary Saving

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  • Christopher D Carroll
  • Miles S Kimball

Abstract

Economists working with numerical solutions to the optimal consumption/saving problem under uncertainty have long known that there are quantitatively important interactions between liquidity constraints and precautionary saving behavior This paper provides the analytical basis for those interactions First we explain why the introduction of a liquidity constraint increases the precautionary saving motive around levels of wealth where the constraint becomes binding Secondwe provide a rigorous basis for the oft-noted similarity between the effects of introducing uncertainty and introducing constraints by showing that in both cases the effects spring from the concavity in the consumption function which either uncertainty or constraints can induce We further show that consumption function concavity once created propagates back to consumption functions in prior periods Finally our most surprising result is that the introduction of additional constraints beyond the first one or the introduction of additional risks beyond a first risk can actually reduce the precautionary saving motive because the new constraint or risk can �hide?the effects of the preexisting constraints or risks

Suggested Citation

  • Christopher D Carroll & Miles S Kimball, 2001. "Liquidity Constraints and Precautionary Saving," Economics Working Paper Archive 455, The Johns Hopkins University,Department of Economics.
  • Handle: RePEc:jhu:papers:455
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    References listed on IDEAS

    as
    1. Christopher D. Carroll, 2001. "A Theory of the Consumption Function, with and without Liquidity Constraints," Journal of Economic Perspectives, American Economic Association, vol. 15(3), pages 23-45, Summer.
    2. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
    3. Veronica Guerrieri & Guido Lorenzoni, 2017. "Credit Crises, Precautionary Savings, and the Liquidity Trap," The Quarterly Journal of Economics, Oxford University Press, vol. 132(3), pages 1427-1467.
    4. Greg Kaplan & Benjamin Moll & Giovanni L. Violante, 2018. "Monetary Policy According to HANK," American Economic Review, American Economic Association, vol. 108(3), pages 697-743, March.
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    6. Deaton, Angus, 1991. "Saving and Liquidity Constraints," Econometrica, Econometric Society, vol. 59(5), pages 1221-1248, September.
    7. Lee, Jeong-Joon & Sawada, Yasuyuki, 2010. "Precautionary saving under liquidity constraints: Evidence from rural Pakistan," Journal of Development Economics, Elsevier, vol. 91(1), pages 77-86, January.
    8. Carroll, Christopher D & Kimball, Miles S, 1996. "On the Concavity of the Consumption Function," Econometrica, Econometric Society, vol. 64(4), pages 981-992, July.
    9. Lee, Jeong-Joon & Sawada, Yasuyuki, 2007. "The degree of precautionary saving: A reexamination," Economics Letters, Elsevier, vol. 96(2), pages 196-201, August.
    10. Holm, Martin Blomhoff, 2018. "Consumption with liquidity constraints: An analytical characterization," Economics Letters, Elsevier, vol. 167(C), pages 40-42.
    11. John Ameriks & Andrew Caplin & Steven Laufer & Stijn Van Nieuwerburgh, 2011. "The Joy of Giving or Assisted Living? Using Strategic Surveys to Separate Public Care Aversion from Bequest Motives," Journal of Finance, American Finance Association, vol. 66(2), pages 519-561, April.
    12. Christian Bayer & Ralph Luetticke & Lien Pham‐Dao & Volker Tjaden, 2019. "Precautionary Savings, Illiquid Assets, and the Aggregate Consequences of Shocks to Household Income Risk," Econometrica, Econometric Society, vol. 87(1), pages 255-290, January.
    13. Arthur Kennickell & Annamaria Lusardi, 2004. "Disentangling the Importance of the Precautionary Saving Mode," NBER Working Papers 10888, National Bureau of Economic Research, Inc.
    14. Jeppe Druedahl & Casper Nordal Jørgensen, 2018. "Precautionary borrowing and the credit card debt puzzle," Quantitative Economics, Econometric Society, vol. 9(2), pages 785-823, July.
    15. Seater, John J., 1997. "An optimal control solution to the liquidity constraint problem," Economics Letters, Elsevier, vol. 54(2), pages 127-134, February.
    16. Besley, Timothy, 1995. "Savings, credit and insurance," Handbook of Development Economics, in: Hollis Chenery & T.N. Srinivasan (ed.), Handbook of Development Economics, edition 1, volume 3, chapter 36, pages 2123-2207, Elsevier.
    17. Tullio Jappelli, 1990. "Who is Credit Constrained in the U. S. Economy?," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 219-234.
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    19. Emilio Fernandez-Corugedo, 2002. "Soft liquidity constraints and precautionary saving," Bank of England working papers 158, Bank of England.
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    More about this item

    JEL classification:

    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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