liquidity constraint

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A limit on the ability of an individual or a firm to borrow as much as they would like to. Individuals, given their expectations, may prefer to consume now and pay later, if they expect that in the future their incomes will be higher or their needs will be less than they are now. Firms may believe that it would be profitable to invest in projects they can only finance by borrowing. Where an individual or a firm has collateral which will make a loan to them safe, or where their reputation inspires lenders to provide loans without collateral, their desired spending plans can be carried out. Individuals and firms without collateral or reputation cannot borrow as much as they would like, or possibly not at all: they are thus liquidity-constrained. Most borrowers are potentially liquidity-constrained: small expenditures can be financed by loans, but for large expenditures a liquidity constraint would apply.

Subjects: Economics.

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