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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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File URL: https://economicdynamics.org/meetpapers/2009/paper_323.pdf
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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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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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