NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Liquidity Constraints and Intertemporal Consumer Optimization: Theory and Evidence From Durable Goods

Eun Young Chah, Valerie A. Ramey, Ross M. Starr

NBER Working Paper No. 3907
Issued in November 1991
NBER Program(s):   EFG

This paper develops and tests a new set of stochastic implications of optimal consumption behavior in the presence of borrowing constraints. In a departure from previous models, the theory shows that liquidity constraints imply a distinctive intertemporal relationship between durable and nondurable good~ consumption. The presence of binding, liquidity constraints are manifested as part of an error correction term from the long-run cointegrating relationship between durables and nondurables. When liquidity constraints are binding, the error correction term will have predictive power for the future change in nondurable consumption. Empirical tests of the implications using aggregate data support the hypothesis that liquidity constraints, rather than rule-of-thumb behavior, best explain the excess sensitivity of consumption to predictable changes in income.

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Document Object Identifier (DOI): 10.3386/w3907

Published: Journal of Money, Credit, and Banking, 27(1): 272-287, (February 1995) citation courtesy of

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