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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

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Bibliographic Info

Paper provided by The Johns Hopkins University,Department of Economics in its series Economics Working Paper Archive with number 455.

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Date of creation: Aug 2001
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Handle: RePEc:jhu:papers:455

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  1. Christopher D. Carroll, 2001. "A Theory of the Consumption Function, With and Without Liquidity Constraints (Expanded Version)," NBER Working Papers 8387, National Bureau of Economic Research, Inc.
  2. Christopher D. Carroll & Miles S. Kimball, 1995. "On the concavity of the consumption function," Finance and Economics Discussion Series 95-10, Board of Governors of the Federal Reserve System (U.S.).
  3. Besley, T., 1993. "Savings, Credit and Insurance," Papers 167, Princeton, Woodrow Wilson School - Development Studies.
  4. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  5. Jappelli, Tullio, 1990. "Who Is Credit Constrained in the U.S. Economy?," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 219-34, February.
  6. Emilio Fernandez-Corugedo, 2002. "Soft liquidity constraints and precautionary saving," Bank of England working papers 158, Bank of England.
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