Liquidity Constraints of the Middle Class
Existing evidence from US middle class households shows that their MPCs out of tax rebates greatly exceed the PIH's prediction and are weakly related to their liquid assets. The standard precautionary saving model predicts the first fact but counterfactu ally requires MPCs to decrease with liquid wealth. Evidence from the Survey of Consumer Finances indicates widespread saving in anticipation of major expenditures like home purchases and college education. Adding such savings to the standard precautionary saving model allows it to generate realistic MPCs for households with liquid wealth: the approaching expenditure simultaneously motivates asset accumulation and raises MPCs by shortening the effective planning horizon. (JEL D14, D15, D31, E21, H24, H31)
American Economic Journal: Economic Policy