An analytical approach to buffer-stock saving under borrowing constraints

Yi Wen

No 2009-026, Working Papers from Federal Reserve Bank of St. Louis

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 buffer-stock saving models with both idiosyncratic and aggregate uncertainties. It is shown analytically that an individual?s optimal consumption plan under uncertainty follows the rule of thumb: Consumption is proportional to a target wealth with the marginal propensity to consume depending on the state of the macroeconomy. The method is applied to addressing two long- standing puzzles: the \"excess smoothness\" and \"excess sensitivity\" of consumption with respect to income changes. Some of my findings sharply contradict the conventional wisdom.

Keywords: Saving and investment; Income (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-bec, nep-dge and nep-mac
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DOI: 10.20955/wp.2009.026

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