CAPITAL MARKETS AND THE SHORT RUN BEHAVIOR OF LIFE CYCLE SAVERS

over the remainder of a lifetime or, through bequests, over the entire future? This paper investigates the effects of capital market imperfections on life cycle savers and reconciles the apparent short run sensitivity with the lifetime planning horizon. Capital market imperfections prevent or dissuade households from spreading the effects of temporary events over the entire lifetime. Effective planning horizons are shorter-as short as a year or less-and the corresponding sensitivity to temporary events is greater-MPCs approach unity. Capital market imperfections are taken here to refer both to differences between borrowing and lending rates confronting households and to quantitative limits on incurring debt. The latter includes both simple restrictions such as borrowing being limited to some multiple of income or net worth, and more complex restrictions, such as (cheaper) mortgage debt being limited to some fraction of the home securing the debt. Keynes' lender's risk [12, p. 1441 provides one explanation for such capital market imperfections even when borrowers fully intend to repay debts and choose their consumption paths as if no uncertainties exist regarding the future. Scale economies and legal and institutional constraints also prevent households from overcoming these imperfections as a practical matter. The literature contains some work related to the current paper, though most includes a simpler representation of capital market constraints on household consumption plans. Russell [17], working in a balanced growth framework, derives conditions under which steady state consumption will be higher in the absence of quantitative limits on borrowing on alternative steady state paths. He does not,