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Liquidity constraints and precautionary saving

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  • Carroll, Christopher D.
  • Holm, Martin B.
  • Kimball, Miles S.

Abstract

We provide the analytical explanation of the interactions between precautionary saving and liquidity constraints. The effects of liquidity constraints and risks are similar because both stem from the same source: a concavification of the consumption function. Since a more concave consumption function exhibits heightened prudence, both constraints and risks strengthen the precautionary saving motive. In addition, we explain the apparently contradictory results that constraints and risks in some cases intensify, but in other cases weaken the precautionary saving motive. The central insight is that the effect of introducing an additional constraint or risk depends on whether it interacts with preexisting constraints or risks. If it does not interact with any preexisting constraints or risks, it intensifies the precautionary motive. If it does interact, it may reduce the precautionary motive in earlier periods at some levels of wealth.

Suggested Citation

  • Carroll, Christopher D. & Holm, Martin B. & Kimball, Miles S., 2021. "Liquidity constraints and precautionary saving," Journal of Economic Theory, Elsevier, vol. 195(C).
    • Handle: RePEc:eee:jetheo:v:195:y:2021:i:c:s0022053121000934
    DOI: 10.1016/j.jet.2021.105276
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    References listed on IDEAS

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    More about this item

    Keywords

    Liquidity constraints; Uncertainty; Precautionary saving;
    All these keywords.

    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
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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