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Liquidity Constraints of the Middle Class

  • Zvi Hercowitz

    (Tel Aviv University)

  • Jeffrey R. Campbell

    (Federal Reserve of Chicago)

This paper combines impatience with large recurring expenditures to replicate the observation that middle-class U.S. households consume much more out of transitory income than permanent income theory predicts. In the present model, households make a large recurring expenditure of exogenous timing and endogenous size; hence, in spite of their impatience, households save in anticipation of this expenditure. When it occurs, a borrowing constraint taking the form of equity requirements on collateralizable durable goods limits household's debt. Although the standard Euler equation usually holds good, the household is always liquidity constrained, in the sense that they value assets that provide liquidity more than their fundamental value. These constraints are strongest when wealth is highest. We contrast a calibrated version of the model with evidence from the 2001 tax rebate.

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Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 323.

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Date of creation: 2009
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Handle: RePEc:red:sed009:323
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  4. Jeffrey R. Campbell & Zvi Hercowitz, 2006. "Welfare implications of the transition to high household debt," Working Paper Series WP-06-27, Federal Reserve Bank of Chicago.
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  17. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  18. Jonathan A. Parker & Nicholas S. Souleles & David S. Johnson & Robert McClelland, 2011. "Consumer Spending and the Economic Stimulus Payments of 2008," NBER Working Papers 16684, National Bureau of Economic Research, Inc.
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