ABSTRACT
A dynamic model of optimal decisions by a poor household, with an infinite horizon and rational expectations over uncertain future income, can be solved and simulated using the technique of orthogonal polynomial projection. The household faces a credit limit, and the interest rate on savings (deposits) differs from the interest rate for loans (borrowing). The decision problem of the poor household is formulated as a Bellman equation. Time is indexed by t. To approximate the long-run distribution of consumption for both the favourable and unfavourable scenarios, the behaviour of a poor household can be simulated using the decision rules. An attempt has been made to solve and simulate a model of financial choices by a poor household with favourable and unfavourable interest rates. The model accounts for the uncertainty of income, the intertemporal nature of financial contracts and the reality of credit limits and of different interest rates for loans and deposits.
