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Liquidity constraint

Liquidity constraint Definition

A liquidity constraint in economic theory is a form of imperfection in the capital market. It causes difficulties for models based on intertemporal consumption.


Many economic models require individuals to save or borrow money from time to time.


A liquidity constraint is an arbitrary limit on the amount an individual can borrow, or an arbitrary alteration in the interest rate they pay. By raising the costs of borrowing, they prevent individuals from fully optimising their behaviour over time.


Actually existing liquidity constraints are mainly due to risk-based behaviour by lenders such as banks.





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