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American Economic Review: Vol. 89 No. 1 (March 1999)

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Rules of Thumb versus Dynamic Programming

Article Citation

Lettau, Martin, and Harald Uhlig. 1999. "Rules of Thumb versus Dynamic Programming." American Economic Review, 89(1): 148-174.

DOI: 10.1257/aer.89.1.148

Abstract

This paper studies decisionmaking with rules of thumb in the context of dynamic decision problems and compares it to dynamic programming. A rule is a fixed mapping from a subset of states into actions. Rules are compared by averaging over past experiences. This can lead to favoring rules which are only applicable in good states. Correcting this good state bias requires solving the dynamic program. The authors provide a general framework and characterize the asymptotic properties. They apply it to provide a candidate explanation for the sensitivity of consumption to transitory income.

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Authors

Lettau, Martin (Federal Reserve Bank of New York and CEPR)
Uhlig, Harald (CentER, Tilburg U and CEPR)

JEL Classifications

C61: Optimization Techniques; Programming Models; Dynamic Analysis
E21: Macroeconomics: Consumption; Saving; Wealth


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