Liquidity Constraints and Precautionary Savings: A Quantitative Analysis

In this paper I quantify the effects of liquidity constraint and precautionary motive of savings in the framework of a stochastic dynamic general equilibrium model. I show that the Zeldes’s estimate [13] of the excess consumption growth for the low asset holders is consistent with the framework when the borrowing constraint point is three months’ worth of average wage income. A Monte Carlo test for the constraint point shows that the estimate is robust both to estimation errors and parameter specifications. Calibrating the model with the estimated borrowing constraint, I show that an increase in endowment shock within the range of empirical findings can cause 1.2% increase in aggregate saving rate and 10% increase in aggregate capital at the steady state.