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Mistakes in Future Consumption, High MPCs Now

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  • Chen Lian

Abstract

In a canonical intertemporal consumption model, future consumption mistakes (in response to saving changes) lead to higher current marginal propensities to consume (MPCs). These mistakes increase the value of changing current consumption relative to changing saving, as additional saving will not be spent optimally. Various behavioral biases can cause these mistakes, such as inattention, present bias, diagnostic expectations, and near-rationality (epsilon-mistakes). This result helps explain the empirical puzzle of high-liquidity consumers' high MPCs. In my approach, predictions of sophistication (anticipation of future mistakes) can be derived independently of the underlying biases.

Suggested Citation

  • Chen Lian, 2023. "Mistakes in Future Consumption, High MPCs Now," American Economic Review: Insights, American Economic Association, vol. 5(4), pages 563-581, December.
    • Handle: RePEc:aea:aerins:v:5:y:2023:i:4:p:563-81
    DOI: 10.1257/aeri.20220452
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    References listed on IDEAS

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    1. Xavier Gabaix, 2014. "A Sparsity-Based Model of Bounded Rationality," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 129(4), pages 1661-1710.
    2. Rava Azeredo da Silveira & Yeji Sung & Michael Woodford, 2020. "Optimally Imprecise Memory and Biased Forecasts," NBER Working Papers 28075, National Bureau of Economic Research, Inc.
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    More about this item

    JEL classification:

    • D15 - Microeconomics - - Household Behavior - - - Intertemporal Household Choice; Life Cycle Models and Saving
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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