The Precautionary Saving Model

2017 ◽  
Author(s):  
Tullio Jappelli ◽  
Luigi Pistaferri
Keyword(s):  
Liquidity Constraints ◽  
Precautionary Saving ◽  
Income Risk ◽  
Quadratic Utility ◽  
Excess Sensitivity

The chapter removes the assumption of quadratic utility and examines situations in which consumers respond to income risk by increasing current saving to protect against future shocks to income. This motive for saving is called precautionary saving, and it provides an explanation for some of the empirical findings in the literature, such as the observation that people with more volatile incomes tend to save more than individuals with more stable income patterns. Moreover, it can also explain the excess sensitivity of consumption to expected income changes. Indeed, a model with precautionary saving produces a good many predictions similar to those of the model with liquidity constraints.

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

2001 ◽  
Vol 15 (3) ◽  
pp. 23-45 ◽  
Author(s):  
Christopher D Carroll
Keyword(s):  
Liquidity Constraints ◽  
Original Description ◽  
Precautionary Saving ◽  
Income Risk ◽  
Labor Income Risk ◽  
Marginal Propensity To Consume ◽  
Precautionary Behavior ◽  
Marginal Propensity ◽  
Future Income ◽  
Relationship Of

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.

The Response of Consumption to Income Risk

2017 ◽  
Author(s):  
Tullio Jappelli ◽  
Luigi Pistaferri
Keyword(s):  
Private Information ◽  
Null Hypothesis ◽  
Indirect Evidence ◽  
Precautionary Saving ◽  
Reduced Form ◽  
Research Strategies ◽  
Income Risk ◽  
Distribution Of Wealth ◽  
Market Incompleteness ◽  
Private Savings

Tests of the importance of precautionary saving follow several research strategies. One aims to find a variable (or set of variables) that can approximate the variance of the growth rate of consumption. A second strategy seeks to estimate a reduced form for the level of consumption and wealth with proxies for income risk. A third approach simulates the path of consumption and wealth in models with precautionary saving, matching simulations with the observed distribution of wealth and consumption. Other studies provide indirect evidence for or against the precautionary saving hypothesis. Finally, some papers test the null hypothesis of the precautionary saving model (or more generally, self-insurance), in which risks can only be insured via private savings, against specific alternatives in which researchers make the source of market incompleteness explicit (positing, for instance, that it is due to private information).

The Buffer Stock Model

2017 ◽  
Author(s):  
Tullio Jappelli ◽  
Luigi Pistaferri
Keyword(s):  
Marginal Utility ◽  
Credit Constraints ◽  
Liquidity Constraints ◽  
Borrowing Constraints ◽  
Precautionary Saving ◽  
Buffer Stock ◽  
Borrowing Constraint ◽  
Stock Model ◽  
Intertemporal Decisions ◽  
Period Model

We analyze models that combine precautionary saving and liquidity constraints to provide a unified, more realistic treatment of intertemporal decisions. We start off with a simple three-period model to illustrate how the expectation of future borrowing constraints can induce precautionary saving even in scenarios in which marginal utility is linear. A more general model that allows liquidity constraints and precautionary saving to interact fully is the buffer stock model, of which there are two versions. One, developed by Deaton (1991), emphasizes the possibility that a prudent and impatient consumer may face credit constraints. The other, by Carroll (1997), features the same type of consumer but allows for the possibility of income falling to zero and so generating a natural borrowing constraint.

The Self-Constrained Hand-to-Mouth

2021 ◽  
pp. 1-45
Author(s):  
Michael Gelman
Keyword(s):  
High Frequency ◽  
Liquidity Constraints ◽  
Exponential Model ◽  
Personal Finance ◽  
Buffer Stock ◽  
The Self ◽  
Proximate Cause ◽  
Ultimate Cause ◽  
Stock Model ◽  
Excess Sensitivity

Abstract Many studies have shown that consumption responds to the arrival of predictable income (excess sensitivity). This paper uses a buffer stock model of consumption to understand what causes excess sensitivity and to test which parametrization is consistent with empirical excess sensitivity estimates. Using high frequency granular data from a personal finance app, it finds that while liquidity constraints are a proximate cause, preferences are the ultimate cause of excess sensitivity. Furthermore, it finds that for feasible parameters, a quasi hyperbolic version of the model is more consistent with the level of excess sensitivity relative to a standard exponential model.

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