Consumption and Saving over the Life Cycle: How Important are Consumer Durables?
Micro data show two key patterns of consumption and asset holdings over the life cycle. First, consumption expenditures on both durable and nondurable goods are hump-shaped. Second, young households keep very few liquid assets and hold most of their wealth in consumer durables. The first pattern persists even after controlling for family size and constitutes a puzzle from the perspective of complete market models, in which individuals smooth consumption over their lifetime. The second pattern suggests that we need to explicitly model durables to understand households' life cycle consumption and portfolio allocation. This paper studies the introduction of consumer durables into a dynamic general equilibrium life cycle model with idiosyncratic income shocks and endogenous borrowing constraints. In this setting durables play a dual role: they provide both consumption services and act as collateral for loans. A plausibly parameterized version of the model predicts that the interaction of consumer durables and endogenous borrowing constraints induces durables accumulation early in life and higher consumption of nondurables and accumulation of financial assets later in the life cycle, in an order of magnitude consistent with observed data. We thus conclude that durables are a key feature to explain both the hump in consumption of durables and nondurables and the optimal asset allocation of households.