Liquidity constraint

Updated: Aug 20, 2021

An arbitrary limit on the amount that an individual or a firm can borrow. 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 finance only by borrowing. In both cases borrowing is necessary to attain the optimal allocation of resources over time. A liquidity constraint that limits borrowing to an amount less than that desired will cause inefficiency by preventing intertemporal optimization.

Reference: Oxford Press Dictonary of Economics, 5th edt.

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