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A Theory of the Consumption Function, With and Without Liquidity Constraints

A Theory of the Consumption Function, With and Without Liquidity Constraints Abstract This paper argues that the modern stochastic consumption model, in which impatient consumers face uninsurable labor income risk, matches Milton Friedman's (1957) original description of the Permanent Income Hypothesis much better than the perfect foresight or certainty equivalent models did. The model can explain the high marginal propensity to consume, the high discount rate on future income, and the important role for precautionary behavior that were all part of Friedman's original framework. The paper also explains the relationship of these questions to the Euler equation literature, and argues that the effects of precautionary saving and liquidity constraints are often virtually indistinguishable. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Economic Perspectives American Economic Association

A Theory of the Consumption Function, With and Without Liquidity Constraints

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Publisher
American Economic Association
Copyright
Copyright © 2001 by the American Economic Association
Subject
Symposia
ISSN
0895-3309
DOI
10.1257/jep.15.3.23
Publisher site
See Article on Publisher Site

Abstract

Abstract This paper argues that the modern stochastic consumption model, in which impatient consumers face uninsurable labor income risk, matches Milton Friedman's (1957) original description of the Permanent Income Hypothesis much better than the perfect foresight or certainty equivalent models did. The model can explain the high marginal propensity to consume, the high discount rate on future income, and the important role for precautionary behavior that were all part of Friedman's original framework. The paper also explains the relationship of these questions to the Euler equation literature, and argues that the effects of precautionary saving and liquidity constraints are often virtually indistinguishable.

Journal

Journal of Economic Perspectives – American Economic Association

Published: Aug 1, 2001

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