Suppose there are shocks in the capital markets that make it impossible for consumers to borrow or save for future consumption. In that case, it implies that consumers would spend their entire income on consumption, making the marginal propensity of consumption equal to one.
Thus, any change in the aggregate expenditure would lead to an infinite process of change in the national income through the multiplier effect.
A rational consumer makes consumption decisions by factoring in the future market conditions. Thus, expectations of increased disposable income in the future induce higher borrowing in the current period, and expectations of income reductions increase present savings.
However, as the consumers do not have the freedom to set money aside or borrow due to capital market complications, they will be unable to make adjustments in the present consumption in anticipation of the future.
Thus, changes in future disposable income will have no impact on present consumption and will only affect the consumption of the period in which the change is taking place.
In this scenario, consumption smoothing will not occur. Consumers' living standards will not be consistent as they will have to alter their consumption based on the future disposable incomes of respective periods.
