Precautionary Saving under Liquidity Constraints: A Decomposition

This paper investigates the effects of liquidity constraints on consumption/saving by separating precautionary saving caused by liquidity constraints (PS2) from the conventional precautionary saving made against income uncertainty (PS1). It is proved that there exists a unique level of wealth below which PS2 is strictly positive and above which liquidity constraints have no effects at all. The numerical simulations show that PS2 is quantitatively important, depending on age and the level of wealth. Some empirical findings in the literature cannot be explained by PS1 alone but are consistent with the model in which PS2 is present. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.