Consumption and Liquidity Constraints: An Empirical Investigation
Several recent studies have suggested that empirical rejections of the permanent income/life cycle model might be due to the existence of liquidity constraints. This paper tests the permanent income hypothesis against the alternative hypothesis that consumers optimize subject to a well specified sequence of borrowing constraints. Implications for consumption in the presence of borrowing constraints are derived and then tested using time series/cross section data on families from the Panel Study of Income Dynamics. The results generally support the hypothesis that an inability to borrow against future labor income affects the consumption of a significant portion of the population.
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