Liquidity Constraints and Durable/Non-durable Consumption Relationship in Iran

In a rational expectation utility optimization model, the consumption profile is smoothed over time and, under some simplifying assumptions, it equals a constant fraction of total lifetime income. For this result to hold, the consumer must be able to transfer income from one period to another. Otherwise, the consumer is under liquidity constraints. The liquidity constraint affects the allocation of durable and non-durable consumption. We focus on the relationship between the marginal utility of household durable good stock and the marginal utility of non-durable consumption. When capital markets are perfect, the marginal utility of these two variables always bears an equilibrium relationship. But if liquidity constraints are binding, the difference between the lagged value of these two variables can predict the current growth change in non-durable consumption. We estimate the long-run relationship between these two variables using an error correction model and a pseudo-panel data set based on Iranian Household Expenditure and Income Surveys (HEIS). In the error correction model, the faster the error of the long-run relationship corrects, the lower the liquidity constraint. This coefficient is estimated to be statistically significant and is in [-0.22, -0.30] range in different estimates, thus we can reject the permanent-income hypothesis and accept that capital markets are not perfect in Iran.