Consumption and Savings
Paper Session
Sunday, Jan. 8, 2023 1:00 PM - 3:00 PM (CST)
- Chair: Daniel Murphy, University of Virginia
Saving for a Sunny Day: An Alternative Theory of Precautionary Savings
Abstract
We pose a new rationale for precautionary savings based on type one extreme value preference shocks. In this framework, the errors of the Euler equation that predicts consumption based on observables has the same properties as the data: the log errors are an affine increasing function of cash in hand. This is not the case with the more standard shocks to the marginal utility of consumption. We characterize the solution to the households’ problem showing how the familiar formulas from static and discrete settings adapt to dynamic and continuous environments. We also show how the existence of these shocks provides utility-enhancing consumption opportunities that justify additional savings beyond those generated by environments with shocks to earnings, something that does not happen with standard shocks to marginal utility. The properties of the Euler equation errors allows us to estimate jointly risk aversion and the variance of the preference shocks.Homeownership, Polarization, and Inequality
Abstract
The rise of income inequality and job polarization have been more pronounced in large U.S. cities. I offer a new explanation: when price-rent and price-wage ratios grow faster in large cities, middle-income households increasingly cannot afford to own a house there. They move to smaller cities and the middle of the income distribution in large cities hollows out, making them more polarized and unequal. I document that (1) commuting zones with higher price growth experienced larger polarization and increase in inequality since 1980 and (2) middle-income households migrate more often to cheaper states for housing-related reasons than low- or high-income households. Using a quantitative spatial equilibrium model with tenure choice and skill heterogeneity, I find that disproportionate growth of prices relative to incomes and rents in large cities accounts for about one-half of the gap in inequality growth and polarization between large and small cities.Microfounding Household Debt Cycles with Extrapolative Expectations
Abstract
Using transaction-level data uniquely paired with survey-based beliefs elicitation for the same consumers, we show that after unexpected positive income shocks consumers on average form excessively positive expectations about future income and debt capacity relative to ex-post realizations. They also raise debt to finance higher current spending, which increases their likelihood of default in the medium run. These effects are larger for lower-income consumers and consumers who face more volatile income streams. Consistent with a model of diagnostic income expectations featuring time-varying income volatility and with aggregate evidence about household debt cycles, the effects of extrapolative beliefs on spending, debt accumulation, and default are asymmetric following positive vs. negative income shocks---reactions are substantially larger after negative shocks relative to positive shocks of similar size.Dominated Pension Investments: The Role of Search Frictions and Unawareness
Abstract
The market for long-term savings in mutual funds is characterized by high price dispersion between similar funds. We conduct a large-scale field experiment in the Swedish pension system to examine to what extent information and search frictions can explain why savers choose dominated high-fee index funds. Three findings stand out: (i) Overall, information letters that increase awareness of a dominated choice and reduce search costs of finding the dominating alternative improve many savers’ real investment choices and can be justified from a cost-benefit analysis. (ii) While the average effects are positive, a majority of previously active investors are unresponsive to information that eliminates search costs. (iii) We estimate that a lack of awareness and search costs account for at most 45 percent of dominated fund choices.JEL Classifications
- E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy