The Economics of Social Protection

The Economics of Social Protection

Lars Söderström

This book focuses on arrangements for redistributing consumption opportunities over the life cycle and for providing compensation for income losses or large expenditures due to reasons such as illness and unemployment. After extensive coverage of the nature of inequalities in income and wealth in a market economy, and various notions of social justice, the author discusses public and private transfers in cash or in kind related to old age, childhood, illness and the like. Importantly, the book takes into account both equity and efficiency aspects.

Chapter 6: Liquidity Constraints

Lars Söderström

Subjects: economics and finance, public finance, public sector economics, welfare economics, social policy and sociology, economics of social policy


The assumption that individuals have access to a perfect capital market in the sense that they may borrow (or save) as much as they want at the prevailing rate of interest is now relaxed. Instead, we assume that credits for household expenditures are rationed. Without the possibility of borrowing as much as they want, individuals will have difficulties optimizing investments and consumption over the life cycle. Some investments – even greatly profitable ones – will be cancelled or at least postponed because of a lack of financing, and the consumption path will not be as smooth as utility maximization prescribes. For obvious reasons, lower middle-aged individuals in particular are hurt by credit rationing. A life cycle model including liquidity constraints is described in the first section. We then go on to look at some measures that are used to compensate especially the lower middle-aged for a lack of credit possibilities. Some aspects of family policy are discussed in the second section, and educational finance is taken up in the third section. MANDATORY PENSIONS AND LIQUIDITY CONSTRAINTS In this section we use simulations to illustrate the role played by mandatory pensions and liquidity constraints in a life cycle model. We are interested in how aggregate saving, among other things, is influenced by the size of mandatory pensions and liquidity constraints. An essential feature of the model presented below is that individuals are uncertain of the time of their death. This has two important implications. First, one’s life expectancy will change...

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