Saving-Constrained Households

We develop a theory of saving-constrained households to explain the following facts that are difficult to reconcile with existing theories: 1) Consumption is excessively volatile relative to income (established fact), 2) a large fraction of high-debt households exhibit marginal propensities to consume near zero, 3) lagged high expenditure is associated with low contemporaneous spending propensities. Our proposed interpretation of these facts is that household expenditure depends on time-varying minimum consumption thresholds that, if violated, yield substantial utility costs. We demonstrate that such a model can match many features of the joint dynamics of income and consumption. Our theory has implications for the propagation of macroeconomic shocks.