Abstract
The profession has been longing for closed-form solutions to consumption functions under uncertainty and borrowing constraints. This paper proposes an analytical approach to solving general-equilibrium buffer-stock saving models with both idiosyncratic and aggregate uncertainties as well as liquidity constraints. It is shown analytically that an individual’s optimal consumption plan follows the rule of thumb: Consumption is proportional to a target level of wealth, with the marginal propensity to consume dependent on the state of the macroeconomy. I apply this method to address two long-standing puzzles in general equilibrium: the excess smoothness and excess sensitivity of consumption with respect to income changes. Some of my findings sharply contradict the conventional wisdom.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
