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Precautionary Saving Unfettered

  • James Feigenbaum

Precautionary saving has engendered much interest, both because of the possibility that it can explain why, contrary to the basic Lifecycle/Permanent-Income Hypothesis, consumption roughly tracks income over the lifecycle and because of speculation that precautionary saving might account for a large fraction of aggregate saving. However, recent findings have indicated that the effects of precautionary saving are much less significant than was first thought. Early researchers did not take into account general equilibrium effects. Furthermore, most research into precautionary saving has employed buffer-stock saving models that also incorporate a borrowing constraint (either imposed exogenously or resulting endogenously from assumptions about the income process). After separating out the effects of uncertainty from the effects of the borrowing constraint, one finds that most buffer-stock saving can be accounted for by the borrowing constraint. However, buffer-stock models make the simple but unrealistic assumption that absolutely no borrowing can occur. While it has generally been assumed that borrowing constraints and precautionary saving are complementary, when these two frictions operate simultaneously a tight no-borrowing constraint will dominate. Here, we show that when borrowing is unconstrained, precautionary saving can, indeed, have significant effects. Moreover, a general equilibrium model of precautionary saving and unconstrained borrowing can better explain the lifecycle consumption profile than the corresponding buffer-stock saving model

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Paper provided by University of Pittsburgh, Department of Economics in its series Working Papers with number 227.

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Date of creation: Jan 2006
Date of revision: Jan 2006
Handle: RePEc:pit:wpaper:227
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  1. Christopher D Carroll, 1990. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," Economics Working Paper Archive 371, The Johns Hopkins University,Department of Economics, revised Aug 1996.
  2. Aiyagari, S Rao, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 659-84, August.
  3. Christopher D Carroll & Miles S Kimball, 2001. "Liquidity Constraints and Precautionary Saving," Economics Working Paper Archive 455, The Johns Hopkins University,Department of Economics.
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