Consumption and Debt Dynamics with (Rarely Binding) Borrowing Constraints

Alexis Anagnostopoulos

No ECO2004/34, Economics Working Papers from European University Institute

Abstract: This paper examines consumption and savings dynamics in a standard model of incomplete markets. Existence of equilibrium requires the imposition of exogenous debt limits but these are often ignored because of the computational difficulties that arise in models with occasionally binding constraints. I claim that borrowing constraints have a significant qualitative and quantitative effect on equilibrium allocations even if they rarely bind. Contrary to standard results in the literature, debt exhibits mean reversion, consumption responds strongly to idiosyncratic income shocks and interest rates respond to both aggregate and idiosyncratic innovations in income. The implication is that market incompleteness can generate much lower consumption correlations than was previously thought.

Keywords: Incomplete markets; consumption/savings dynamics; non-linear dynamic methods (search for similar items in EconPapers)
JEL-codes: C63 E21 E32 (search for similar items in EconPapers)
Date: 2004
New Economics Papers: this item is included in nep-fmk and nep-mac
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eui:euiwps:eco2004/34

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