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An analytical approach to buffer-stock saving

  • Yi Wen
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The profession has been longing for closed-form solutions to consumption functions under uncertainty and borrowing constraints. This paper proposes an analytical approach to solving buffer-stock saving models with both idiosyncratic and aggregate uncertainties. It is shown analytically that an individual’s optimal consumption plan under uncertainty follows the rule of thumb: Consumption is proportional to a target wealth with the marginal propensity to consume depending on the state of the macroeconomy. The method is applied to addressing two long- standing puzzles: the "excess smoothness" and "excess sensitivity" of consumption with respect to income changes. Some of my findings sharply contradict the conventional wisdom.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2009-026.

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Date of creation: 2009
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Handle: RePEc:fip:fedlwp:2009-026
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