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We propose a model of household consumption that explicitly accounts for unexpected
expenditure shocks such as automobile repairs. We highlight the relevance of
unanticipated expenditure by documenting a number of striking features of the microdata:
1) household-level consumption is as volatile as household income on average, 2)
household-level consumption is relatively uncorrelated with income, 3) a large fraction
of low-wealth households exhibit marginal propensities to consume near zero, and 4)
lagged high expenditure is associated with low contemporaneous spending propensities.
Our proposed interpretation of these facts is that household expenditure depends
on time-varying minimum consumption thresholds that, if violated, yield substantial
utility costs. We embed minimum consumption thresholds in an incomplete market
heterogeneous-agent model and demonstrate that the minimum consumption thresholds
are binding for many households. These households are “saving-constrained,” and
they use additional income to save rather than spend.
