liquidity constraints


This paper tests the rational expectations lifecycle model of consumption
against (i) a simple Keynesian model and (ii) the rational expectations
lifecycle model with imperfect capital markets. The tests are based upon the
relative responsiveness of consumption to income changes which can be
predicted from past information and income changes which cannot be predicted.
Problems caused by measurement error in the income changes are circumvented by
using the innovations from a vector autoregression of the measures of the
determinants of income to form a noisy instrument for the unanticipated change
in incomfi and using the lagged values of the measures of the income
determinants to form an instrument for the anticipated income change. We show
that the Keynesian model implies that the regression coefficients relating the
change in consumption to the instruments for the anticipated and unanticipated
components of the income change should be equal. The lifecycle model (with
perfect capital markets) implies that only the instrument for the
unanticipated component should affect consumption. The empirical results
support the lifecycle model. In addition, we incorporate capital market
imperfections into our empirical formulation of the lifecycle model by
assuming that the marginal interest rate at a point in time is a
differentiable, concave function of net assets. This leads to a test for
capital market imperfections based upon whether consumption responds
differently to positive and negative predictable changes in income. Our
results are inconclusive.

Year of Publication
Date Published
Publication Language
Citation Key
Quarterly Journal of Economics, vol. 102, no.2, May 1987
Siow, A., & Altonji, J. (1985). Testing the Response of Consumption to Income Changes. Retrieved from (Original work published April 1985)
Working Papers

We examine why some individuals survive as entrepreneurs and others do not. In
addition. we analyze the growth of entrepreneurial enterprises, conditional on surviving. Our
focus is on the role of access to capital--to what extent do liquidity constraints increase the
likelihood of entrepreneurial failure?
The empirical strategy is based on the following logic: If entrepreneurs cannot borrow
to attain their profit-maximizing levels of capital, then those entrepreneurs who have substantial
personal financial resources will be more successful than those who do not. The data consist of
the 1981 and 1985 federal individual income tax returns of a group of people who received
inheritances. These data allow us to identify those individuals who were sole proprietors in
1981, and to determine the extent to which the decision to remain a sole proprietor was
influenced by the magnitude of the inheritance-induced increase in liquidity.
The results are consistent with the notion that liquidity constraints exert a noticeable
influence on the viability of entrepreneurial enterprises. For example, a $150,000 inheritance
increases the probability that an individual will continue as a sole proprietor by 1.3 percentage
points, and conditional on surviving, the receipts of the enterprise increase by almost 20

Year of Publication
Date Published
Publication Language
Citation Key
Journal of Political Economy, February 1994
Rosen, H., Holtz-Eakin, D., & Joulfaian, D. (1993). Sticking It Out: Entrepreneurial Survival and Liquidity Constraints. Retrieved from (Original work published October 1993)
Working Papers