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A Theory of the Consumption Function, With and Without Liquidity Constraints (Expanded Version)

  • Christopher D. Carroll

This paper argues that the modern stochastic consumption model, in which impatient consumers face uninsurable labor income risk, matches Milton Friedman's (1957) original description of the Permanent Income Hypothesis much better than the perfect foresight or certainty equivalent models did. The model can explain the high marginal propensity to consume, the high discount rate on future income, and the important role for precautionary behavior that were all part of Friedman's original framework. The paper also explains the relationship of these questions to the Euler equation literature, and argues that the effects of precautionary saving and liquidity constraints are often virtually indistinguishable.

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File URL: http://www.nber.org/papers/w8387.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8387.

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Date of creation: Jul 2001
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Publication status: published as Carroll, Christopher D. "A Theory Of The Consumption Function, With And Without Liquidity Constraints," Journal of Economic Perspectives, 2001, v15(3,Summer), 23-45.
Handle: RePEc:nbr:nberwo:8387
Note: ME
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  1. Carol C. Bertaut & Michael Haliassos, 1996. "Precautionary Portfolio Behavior from a Life-Cycle Perspective," Finance 9604001, EconWPA.
  2. Todd W Allen & Christopher D Carroll, 2001. "Individual Learning About Consumption," Economics Working Paper Archive 444, The Johns Hopkins University,Department of Economics.
  3. Campbell, John Y. & Mankiw, N. Gregory, 1991. "The response of consumption to income : A cross-country investigation," European Economic Review, Elsevier, vol. 35(4), pages 723-756, May.
  4. Campbell, John Y & Deaton, Angus, 1989. "Why Is Consumption So Smooth?," Review of Economic Studies, Wiley Blackwell, vol. 56(3), pages 357-73, July.
  5. repec:cup:macdyn:v:5:y:2001:i:2:p:255-71 is not listed on IDEAS
  6. Christopher D. Carroll, 1996. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," NBER Working Papers 5788, National Bureau of Economic Research, Inc.
  7. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(2), pages 61-156.
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