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The Implications of Lower Down Payments on Consumption Volatility

  • Christopher Farr and Maria J. Luengo-Prado
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    We examine the effects of decreasing down payment requirements on consumption volatility within a model which generalizes the standard buffer-stock model of saving to accommodate durables, nondurables and a collateralized liquidity constraint. We consider both a version of the model without adjustment costs in the durable goods market and a version with adjustment costs. Since there is no known analytical solution to the model, we solve it numerically. We find that nondurable consumption becomes more volatile as down payment requirements decrease. This finding is true for both individual and aggregate consumption, and it is robust to the inclusion of adjustment costs. Transitional dynamics imply that a financial liberalization leads to a temporary consumption boom.

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    Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2001 with number 196.

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    Date of creation: 01 Apr 2001
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    Handle: RePEc:sce:scecf1:196
    Contact details of provider: Web page: http://www.econometricsociety.org/conference/SCE2001/SCE2001.html
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    1. Chris Carroll & Wendy Dunn, 1997. "Unemployment Expectations, Jumping (S,s) Triggers, and Household Balance Sheets," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 165-230 National Bureau of Economic Research, Inc.
    2. Alessie, Rob & Devereux, Michael P. & Weber, Guglielmo, 1997. "Intertemporal consumption, durables and liquidity constraints: A cohort analysis," European Economic Review, Elsevier, vol. 41(1), pages 37-59, January.
    3. Browning, M. & Crossley, T., 1999. "Shocks, Stocks and Socks: Consumption Smoothing and the Replacement of Durables During an Unemployment Spell," Papers 376, Australian National University - Department of Economics.
    4. Abowd, John M & Card, David, 1989. "On the Covariance Structure of Earnings and Hours Changes," Econometrica, Econometric Society, vol. 57(2), pages 411-45, March.
    5. Bayoumi, Tamim, 1993. "Financial Deregulation and Household Saving," Economic Journal, Royal Economic Society, vol. 103(421), pages 1432-43, November.
    6. 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.
    7. Bernanke, Ben S, 1984. "Permanent Income, Liquidity, and Expenditure on Automobiles: Evidence from Panel Data," The Quarterly Journal of Economics, MIT Press, vol. 99(3), pages 587-614, August.
    8. Brugiavini, A. & Weber, G., 1992. "Durables and Nondurables Consumption: Edidence from Italian Household Data," Papers 184, Banca Italia - Servizio di Studi.
    9. Orazio P. Attanasio, 1998. "Consumption Demand," NBER Working Papers 6466, National Bureau of Economic Research, Inc.
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