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A Life-Cycle Consumption Model with Liquidity Constraints: Theory and Empirical Results
Randall P. Mariger
Abstract
This paper uses data for a cross-section of 798 U.S. families to estimate a life-cycle consumption model that incorporates endogenous liquidity constraints. The model assumes that families maximize intertemporal utility subject to the constraint that net worth always exceed a portion of consumption expenditure (transactions balances) and a minimal amount of equity in home(s) and automobile(s). Liquidity constraints shorten the family's effective planning horizon, which extends to a time that the family expects to first encounter binding borrowing constraints. Families with short multiperiod planning horizons are liquidity constrained but do not necessarily consume in accordance with their contemporaneous disposable income. The estimated model explains over 60 per cent of the consumption variance of families in the lower 99.1 per cent of the wealth distribution. Wealthier families appear to plan substantial bequests. Liquidity constrained families are estimated to constitute 19.4 per cent of the population sampled, a group that accounts for 16.7 per cent of consumption in the population sampled. More than half of these families have short multiperiod horizons. In-sample simulations of the model suggest that a temporary tax has three to four times more impact on aggregate consumption than it would if liquidity constraints were not in effect.
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