The Implications of Lower Down Payments on Consumption Volatility

We examine the effects of decreasing down payment requirements on consumption volatility within a model which generalizes the standard buffer-stock model of saving to accommodate durables, nondurables and a collateralized liquidity constraint. We consider both a version of the model without adjustment costs in the durable goods market and a version with adjustment costs. Since there is no known analytical solution to the model, we solve it numerically. We find that nondurable consumption becomes more volatile as down payment requirements decrease. This finding is true for both individual and aggregate consumption, and it is robust to the inclusion of adjustment costs. Transitional dynamics imply that a financial liberalization leads to a temporary consumption boom.