Liquidity Constraints and Buffer Stock Savings: Theory and Experimental Evidence

Abstract

We provide a direct, experimental test of the buffer stock model of savings behavior. We use a three-period inter-temporal model of consumption/savings decisions where liquidity in the second period is constrained (and, thus, borrowing is not possible). We contrast behavior in this constrained version of the model with an unconstrained version where there is no liquidity constraint. A second treatment variable is the variance of the stochastic income process, resulting in a 2x2 experimental design. We test the comparative statics predictions of the model and find that, in contrast to these predictions, the liquidity constraint does not increase savings in the first period of the constrained model relative to the first period of the unconstrained model. However, we find strong support for all the other comparative statics predictions of the model, e.g., the impact of a higher variance of income on savings behavior and differences between period 1 and period 2 savings. In further analyses, we find that we can rationalize the departures we observe from model predictions by some combination of debt aversion, heterogeneity in cognitive abilities and/or learning.