A class of macroeconomic models in which households face uninsurable idiosyncratic income risk and cannot fully borrow or hedge against it, so they build precautionary savings buffers. This produces heterogeneous consumption responses and a marginal propensity to consume that varies across the wealth distribution.
Households face idiosyncratic income shocks they cannot insure because asset markets are incomplete — typically only a single risk-free bond with a borrowing constraint exists. Facing downside risk and unable to hedge, agents accumulate precautionary buffers, which generates a non-degenerate wealth distribution and an aggregate MPC far above the representative-agent benchmark, especially among constrained, hand-to-mouth households.
Incomplete-markets (HANK-style) models underpin how central banks now think about fiscal transfers, the distributional bite of rate hikes, and consumption resilience — but the 2023-2025 episode of households spending down excess savings amid a strong labour market complicates the standard prediction that anxious consumers hoard.
In Aiyagari's 1994 calibration, introducing uninsurable labour-income risk and a borrowing constraint raised the aggregate capital stock and pushed the equilibrium real interest rate below the representative-agent rate, as households over-save for precaution. Modern HANK descendants (Kaplan-Moll-Violante, 2018) use the same machinery to show that a fiscal transfer hits aggregate demand harder than the permanent-income model predicts, because high-MPC constrained households spend it immediately rather than smoothing it over a lifetime.
max E Σ βᵗ u(cₜ) s.t. cₜ + aₜ₊₁ = (1+r)aₜ + yₜ, aₜ₊₁ ≥ a̲ (borrowing constraint), yₜ uninsurable