Household saving behavior under liquidity constraints

A. Talha Yalta, Fordham University


Binding liquidity constraints is a commonly cited explanation for the empirical failure of the standard life-cycle permanent income hypothesis. The down payment required for a mortgage loan is a well defined liquidity constraint and an average household faces this limitation at some point in their lifetime. Consequently, we propose an original dynamic model custom-tailored for studying the impact of this constraint type on household consumption and saving. In our model, the consumer deliberately sacrifices today's consumption in order to accumulate the down payment required for the purchase of a high denomination asset, which provides a steady stream of utility for a long period. We provide empirical support for the model by conducting a pooled cross-sectional analysis using the Panel Study of Income Dynamics (P.S.I.D.) data on U.S. households covering different periods between 1984 and 2003. Notwithstanding the relatively low borrowing constraints, we find evidence that a significant part of the overall household saving can be explained with liquidity constraints in the form of down payments. This result is useful for explaining various issues in the literature such as the cross-country and long-run within a country variations in saving rates. (JEL E21)

Subject Area

Economics|Economic theory

Recommended Citation

Yalta, A. Talha, "Household saving behavior under liquidity constraints" (2007). ETD Collection for Fordham University. AAI3271280.