Precautionary saving under liquidity constraints: Evidence from rural Pakistan

This paper investigates precautionary saving under liquidity constraints in Pakistan using household panel data. In particular, while it estimates Kimball's [Kimball, M.S. Precautionary saving in the small and in the large. Econometrica 1990; 58; 53-73.] prudence parameter based on a framework that is similar to Dynan [Dynan, K.E. How prudent are consumers? Journal of Political Economy 1993; 101; 1104-1113.], this study deviates from the framework by explicitly considering liquidity constraints, as in Zeldes [Zeldes, S.P. Consumption and liquidity constraints: an empirical investigation. Journal of Political Economy 1989; 97; 305-346.]. By doing so, this paper attempts to differentiate the standard precautionary saving caused by uncertainty from that caused by liquidity constraints. Furthermore, endogenous liquidity constraints are used in order to resolve issues of selection biases. We find substantial evidence of the presence of precautionary saving in Pakistan. More specifically, the estimated prudence is significantly higher for liquidity-constrained households as compared with unconstrained ones. The finding suggests that the precautionary saving motives appear stronger when households see that their access to credit markets is limited.