This paper is concerned with the theory of saving when consumers are not
permitted to borrow, and with the ability of such a theory to account for some
of the stylized facts of saving behavior. When consumers are relatively
impatient, and when labor income is independently and identically distributed
over time, assets act like a buffer stock, protecting consumption against bad
draws of income. The precautionary demand for saving interacts with the
borrowing constraints to provide a motive for holding assets. If the income
process is positively autocorrelated, but stationary, assets are still used to
buffer consumption, but do so less effectively, and at a greater cost in terms
of foregone consumption. In the limit, when labor income is a random walk, it
is optimal for impatient liquidity constrained consumers simply to consume
their incomes. As a consequence, a liquidity constrained representative agent
cannot generate aggregate U.S. saving behavior if that agent receives aggregate
labor income. Either there is no saving, when income is a random walk, or
saving is contracyclical over the business cycle, when income changes are
positively autocorrelated. However, in reality, microeconomic income processes
do not resemble their average, and it is possible to construct a model of
microeconomic saving under liquidity constraints which, at the aggregate level,
reproduces many of the stylized facts in the actual data. While it is clear
that many households are not liquidity constrained, and do not behave as
described here, the models presented in the paper seem to account for important
aspects of reality that are not explained by traditional life-cycle models.
*Published:
Econometrica, Vol. 59, No. 5, pp. 1221-1248, (September 1991).
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