Theories of consumption and fiscal policy.

This thesis examines, within the overlapping generations framework, aspects of theories of consumption and fiscal policy under particular liquidity constraints and the effects of life-time earnings. The study consists of three parts; the theoretical analysis, the estimation of required parameters using the UK New Earnings Survey data and the calibration and simulation of our developed models. Firstly we introduce liquidity constrained consumers into an aggregate consumption function and then discuss, theoretically, the effect of these consumers in steady-state. Our comparative analysis shows that this effect could be significantly affecting steady-state parameters, i.e. capital stock and interest rates, and hence consumption. We also conclude that Ricardian equivalence fails not only because of a positive probability of death but due to liquidity constraints. It is clear that fiscal policy is even more important in an economy where most of the consumers are liquidity constrained. In our first simulation experiment we examine these consumers in an equilibrium approach by introducing liquidity constraints to our closed economy model. This investigation is done using a control framework which is concerned with uncertainty and time inconsistency. Our results emphasise that the outcome of a policy model which does not take into account liquidity constraints, would be misleading. With respect to the life-cycle of earnings, we use the New Earnings Survey data to estimate the parameters of our age-earnings profiles. Our examination contains age- earnings, in the UK for the last 20 years and the data clearly indicates that the age earnings profile has a parabolic structure as was previously argued. In our second simulation experiment, we introduce the life-cycle of earnings into our closed economy model and find that the life-cycle effect is significant. More intuitively, a life-cycle form of earnings affects the aggregate consumption in different ways compared to the case where earnings are a constant or declining function of age. We conclude that any implemented macroeconomic policy model should consider the life-cycle of earnings.