Testing for Liquidity Constraints in Euler Equations with Complementary Data Sources

Previous tests for liquidity constraints using consumption Euler equations have frequently used asset-based sample separation rules, arguing that low wealth consumers are more likely to be constrained. We propose an alternative sample separation rule using direct information on borrowing constraints provided in the US Survey of Consumer Finances. We estimate probabilities of being liquidity constrained which are then used in a second sample, the Panel Study of Income Dynamics, to estimate a switching regression model for the Euler equation. The estimates indicate that the conditional mean of consumption growth is not strongly affected by the probability of liquidity constraints. Quantile regressions suggest that liquidity constraints affect the conditional distribution of consumption in the constrained and unconstrained regimes in a way consistent with theoretical simulations, however. We interpret these findings as weak evidence that liquidity constraints affect the intertemporal allocation of food consumption.