Optimal consumption with time-inconsistent preferences
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Optimal consumption with time-inconsistent preferences Liya Liu1,2 · Yingjie Niu2 · Yuanping Wang2,3 · Jinqiang Yang1,2 Received: 10 June 2018 / Accepted: 21 September 2019 © Springer-Verlag GmbH Germany, part of Springer Nature 2019
Abstract This paper extends the standard continuous-time buffer-stock savings model with borrowing constraints by introducing time-inconsistent agent preferences. Interestingly, it predicts that time-inconsistent preferences will strengthen the consumption motive, and this makes the agent’s borrowing constraints more severe and generates higher MPCs out of liquidity, which provides an alternative explanation for the “excess sensitivity” to liquidity from the perspective of time-inconsistent preferences. Moreover, by incorporating time-inconsistent preferences, our theoretical model also provides support for the empirical evidence of “excess smoothness.” Keywords Time-inconsistent preferences · MPC · Excess sensitivity · Excess smoothness JEL Classification D11 · D91 · E21 · G11
We thank the anonymous referees for helpful comments. Liya Liu acknowledges the support from a Major Project of the National Social Science Foundation of China (16ZDA035), the National Natural Science Foundation of China (71573167). Yingjie Niu acknowledges the support from the Postgraduate Students Innovation Foundation of Shanghai University of Finance and Economics (CXJJ-2018-320). Yuanping Wang acknowledges the support from the Postgraduate Students Innovation Foundation of Shanghai University of Finance and Economics (CXJJ-2017-328). Jinqiang Yang acknowledges the support from the National Natural Science Foundation of China (71772112, 71972122), Innovative Research Team of Shanghai University of Finance and Economics (2016110241).
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Yuanping Wang [email protected] Liya Liu [email protected] Yingjie Niu [email protected] Jinqiang Yang [email protected]
1
Shanghai Institute of International Finance and Economics, Shanghai, China
2
School of Finance, Shanghai University of Finance and Economics, Shanghai, China
3
School of Finance, Shanxi University of Finance and Economics, Taiyuan, China
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L. Liu et al.
1 Introduction Empirical estimates of the marginal propensity to consume (MPC) range from 0.2 to 0.6 in Parker (1999) and Souleles (1999) and from 0.12 to 0.3 in Parker et al. (2013). However, it is extremely difficult to use traditional theoretical models, such as the rational expectations–permanent income hypothesis, to generate such high MPC values, which is referred to as the “excess sensitivity” to liquidity.1 Carroll (2001) notes that an agent’s preferences have important effects on consumption’s sensitivity to liquidity. Moreover, there is a considerable literature and evidence, arguing that agent preferences are dynamically inconsistent (see, e.g., Thaler 1981; Ainslie 1992; Loewenstein and Prelec 1992; Laibson 1997). As Strotz (1955) illustrated, if an individual does not discount all future consumption utility at a constant rate, her future behavior wi
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