D91 Intertemporal Consumer Choice; Life Cycle Models and Saving
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We document the individual willingness to act against climate change and study the role of social norms in a large sample of US adults. Individual beliefs about social norms positively predict pro-climate donations, comparable in strength to universal moral values and economic preferences such as patience and reciprocity. However, we document systematic misperceptions of social norms. Respondents vastly underestimate the prevalence of climate-friendly behaviors and norms. Correcting these misperceptions in an experiment causally raises individual willingness to act against climate change as well as individual support for climate policies. The effects are strongest for individuals who are skeptical about the existence and threat of global warming.
Shallow meritocracy
(2023)
Meritocracies aspire to reward hard work and promise not to judge individuals by the circumstances into which they were born. However, circumstances often shape the choice to work hard. I show that people's merit judgments are "shallow" and insensitive to this effect. They hold others responsible for their choices, even if these choices have been shaped by unequal circumstances. In an experiment, US participants judge how much money workers deserve for the effort they exert. Unequal circumstances disadvantage some workers and discourage them from working hard. Nonetheless, participants reward the effort of disadvantaged and advantaged workers identically, regardless of the circumstances under which choices are made. For some participants, this reflects their fundamental view regarding fair rewards. For others, the neglect results from the uncertain counterfactual. They understand that circumstances shape choices but do not correct for this because the counterfactual—what would have happened under equal circumstances—remains uncertain.
The complexities of geopolitical events, financial and fiscal crises, and the ebb and flow of personal life circumstances can weigh heavily on individuals’ minds as they make critical economic decisions. To investigate the impact of cognitive load on such decisions, the authors conducted an incentivized online experiment involving a representative sample of 2,000 French households. The results revealed that exposure to a taxing and persistent cognitive load significantly reduced consumption, particularly for individuals under the threat of furlough, while simultaneously increasing their account balances, particularly for those not facing such employment uncertainty. These effects were not driven by supply constraints or a worsening of credit constraints. Instead, cognitive load primarily affected the optimality of the chosen policy rules and impaired the ability of the standard economic model to accurately predict consumption patterns, although this effect was less pronounced among college-educated subjects
We analyze efficient risk-sharing arrangements when the value from deviating is determined endogenously by another risk sharing arrangement. Coalitions form to insure against idiosyncratic income risk. Self-enforcing contracts for both the original coalition and any coalition formed (joined) after deviations rely on a belief in future cooperation which we term "trust". We treat the contracting conditions of original and deviation coalitions symmetrically and show that higher trust tightens incentive constraints since it facilitates the formation of deviating coalitions. As a consequence, although trust facilitates the initial formation of coalitions, the extent of risk sharing in successfully formed coalitions is declining in the extent of trust and efficient allocations might feature resource burning or utility burning: trust is indeed a double-edged sword.
We consider an additively time-separable life-cycle model for the family of power period utility functions u such that u0(c) = c−θ for resistance to inter-temporal substitution of θ > 0. The utility maximization problem over life-time consumption is dynamically inconsistent for almost all specifications of effective discount factors. Pollak (1968) shows that the savings behavior of a sophisticated agent and her naive counterpart is always identical for a logarithmic utility function (i.e., for θ = 1). As an extension of Pollak’s result we show that the sophisticated agent saves a greater (smaller) fraction of her wealth in every period than her naive counterpart whenever θ > 1 (θ < 1) irrespective of the specification of discount factors. We further show that this finding extends to an environment with risky returns and dynamically inconsistent Epstein-Zin-Weil preferences.
This paper investigates retirees’ optimal purchases of fixed and variable longevity income annuities using their defined contribution (DC) plan assets and given their expected Social Security benefits. As an alternative, we also evaluate using plan assets to boost Social Security benefits through delayed claiming. We determine that including deferred income annuities in DC accounts is welfare enhancing for all sex/education groups examined. We also show that providing access to well-designed variable deferred annuities with some equity exposure further enhances retiree wellbeing, compared to having access only to fixed annuities. Nevertheless, for the least educated, delaying claiming Social Security is preferred, whereas the most educated benefit more from using accumulated DC plan assets to purchase deferred annuities.
The US Treasury recently permitted deferred longevity income annuities to be included in pension plan menus as a default payout solution, yet little research has investigated whether more people should convert some of the $18 trillion they hold in employer-based defined contribution plans into lifelong income streams. We investigate this innovation using a calibrated lifecycle consumption and portfolio choice model embodying realistic institutional considerations. Our welfare analysis shows that defaulting a modest portion of retirees’ 401(k) assets (over a threshold) is an attractive way to enhance retirement security, enhancing welfare by up to 20% of retiree plan accruals.
Many consumers care about climate change and other externalities associated with their purchases. We analyze the behavior and market effects of such “socially responsible consumers” in three parts. First, we develop a flexible theoretical framework to study competitive equilibria with rational consequentialist consumers. In violation of price taking, equilibrium feedback non-trivially dampens a consumer’s mitigation efforts, undermining responsible behavior. This leads to a new type of market failure, where even consumers who fully “internalize the externality” overconsume externality-generating goods. At the same time, socially responsible consumers change the relative effectiveness of taxes, caps, and other policies in lowering the externality. Second, since consumer beliefs about and preferences over dampening play a crucial role in our framework, we investigate them empirically via a tailored survey. Consistent with our model, consumers are predominantly consequentialist, and on average believe in dampening. Inconsistent with our model, however, many consumers fail to anticipate dampening. Third, therefore, we analyze how such “naive” consumers modify our theoretical conclusions. Naive consumers behave more responsibly than rational consumers in a single-good economy, but may behave less responsibly in a multi-good economy with cross-market spillovers. A mix of naive and rational consumers may yield the worst outcomes.
This paper characterizes the stationary equilibrium of a continuous-time neoclassical production economy with capital accumulation in which households can insure against idiosyncratic income risk through long-term insurance contracts. Insurance companies operating in perfectly competitive markets can commit to future contractual obligations, whereas households cannot. For the case in which household labor productivity takes two values, one of which is zero, and where households have logutility we provide a complete analytical characterization of the optimal consumption insurance contract, the stationary consumption distribution and the equilibrium aggregate capital stock and interest rate. Under parameter restrictions, there is a unique stationary equilibrium with partial consumption insurance and a stationary consumption distribution that takes a truncated Pareto form. The unique equilibrium interest rate (capital stock) is strictly decreasing (increasing) in income risk. The paper provides an analytically tractable alternative to the standard incomplete markets general equilibrium model developed in Aiyagari (1994) by retaining its physical structure, but substituting the assumed incomplete asset markets structure with one in which limits to consumption insurance emerge endogenously, as in Krueger and Uhlig (2006).
This paper studies insurance demand for individuals with limited financial literacy. We propose uncertainty about insurance payouts, resulting from contract complexity, as a novel channel that affects decision-making of financially illiterate individuals. Then, a trade-off between second-order (risk aversion) and third-order (prudence) risk preferences drives insurance demand. Sufficiently prudent individuals raise insurance demand upon an increase in contract complexity, while the effect is reversed for less prudent individuals. We characterize competitive market equilibria that feature complex contracts since firms face costs to reduce complexity. Based on the equilibrium analysis, we propose a monetary measure for the welfare cost of financial illiteracy and show that it is mainly driven by individuals’ risk aversion. Finally, we discuss implications for regulation and consumer protection.