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Working Paper, No. 2009-20, November 2009
Liquidity Constraints of the Middle Class (REVISED June 2016)
Existing evidence from the U.S. middle class shows that the MPC out of tax rebates is either invariant to household liquid assets or a U-shaped function thereof. In contrast, precautionary savings models predict a monotone decreasing relationship. We bridge this gap with term saving: households' savings for large foreseen expenditures, which we find empirically widespread. Once incorporated into a calibrated precautionary savings model, term saving generates empirically realistic MPCs. This is because the approaching expenditure simultaneously motivates asset accumulation and raises MPCs by shortening the effective planning horizon. We conclude that liquidity constraints of the middle class are quantitatively important.

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