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Analyzing account-level data from an account aggregator, we find that households increase consumption when they receive expected tax refunds, as if they face liquidity constraints. However, these same households smooth consumption when making payments in other years, primarily by transferring funds among liquid accounts. Even households carrying credit card debt smooth consumption when making payments, and even highly liquid households spend out of refunds. This behavior is inconsistent with pure liquidity constraints or hand-to-mouth behavior and is most consistent with a mental accounting life-cycle model. (JEL D12, E21, G51, H24, H31)

© 2019 The Ohio State University Using variation in minimum wages across cities and controlling for differences in business-cycle factors and long-run local economic trends, we find that following minimum wage increases, both, prices and nominal spending rise modestly. These gains are larger for certain subcategories of goods such as food away from home and in locations where low-wage workers account for a larger share of employment. Further, minimum wage increases are associated with reduced total debt among households with low credit scores, higher auto debt, and increased access to credit.

We evaluate the consistency of two methods for estimating the effect of an economic policy: (i) asking people how the policy caused them to change their behavior (reported effects) and (ii) inferring this change using data on behavior and differences in treatment across people (revealed-preference estimates). Both methods are widely used to measure spending caused by increases in liquidity. Using federal stimulus payments disbursed quasi-randomly in 2008, we find larger revealed-preference estimates of spending propensities for households who report greater spending responses, and the methods produce similar average propensities. But evidence is mixed on the relationship between spending propensities and liquidity. (JEL C83, D14, D91, E62, H24, H31)

This paper evaluates theoretical explanations for the propensity of households to increase spending in response to the arrival of predictable, lump-sum payments, using households in the Nielsen Consumer Panel who received $25 million in randomly distributed stimulus payments. The pattern of spending is inconsistent with models in which identical households cycle rapidly through high and low- response states as they manage liquidity, but is instead highly predictable by income years before the payment. Spending responses are unrelated to expectation errors, almost unrelated to crude measures of procrastination and self-control, significantly related to sophistication and planning, and highly related to impatience. (JEL D12, D14, D91, E21, H23)

We develop a structural theory of beliefs and behavior that relaxes the assumption of time consistency in beliefs. Our theory is based on the trade-off between optimism, which raises anticipatory utility, and objectivity, which promotes efficient actions. We present it in the context of allocating work on a project over time, develop testable implications to contrast it with models assuming time-inconsistent preferences, and compare its predictions to existing evidence on behavior and beliefs. Our predictions are that (i) optimal beliefs are optimistic and time inconsistent; (ii) people optimally exhibit the planning fallacy; (iii) incentives for rapid task completion make beliefs more optimistic and worsen work smoothing, whereas incentives for accurate duration prediction make beliefs less optimistic and improve work smoothing; (iv) without a commitment device, beliefs become less optimistic over time; and (v) in the presence of a commitment device, beliefs may become more optimistic over time, and people optimally exhibit preference for commitment. This paper was accepted by Neng Wang, finance.

Under the Economic Growth and Tax Relief Reconciliation Act of 2001, most U.S. taxpayers received a tax rebate between July and September, 2001. The week in which the rebate was mailed was based on the second-to-last digit of the taxpayer's Social Security number, a digit that is effectively randomly assigned. Using special questions about the rebates added to the Consumer Expenditure Survey, we exploit this historically unique experiment to measure the change in consumption expenditures caused by receipt of the rebate and to test the Permanent Income Hypothesis and related models. We find that households spent about 20-40 percent of their rebates on non-durable goods during the three-month period in which their rebates were received, and roughly another third of their rebates during the subsequent three-month period. The implied effects on aggregate consumption demand are significant. The estimated responses are largest for households with relatively low liquid wealth and low income, consistent with liquidity constraints.

This paper uses the consumption Euler equation to derive a decomposition of consumption growth into four sources. These four sources are new information, and three sources of predictable consumption growth: intertemporal substitution, changes in the preferences for consumption, and incomplete markets for consumption insurance. Using household-level data, we implement this decomposition for the average growth rate of consumption expenditures on nondurable goods in the United States from 1982 to 1997. The economic importance of precautionary saving rivals that of the real interest rate, but the relative importance of each source of movement in the volatility of consumption is not precisely measured.

U.S. stock returns are large, predictable over time, and predictable across stocks. The average return on a diversified market portfolio has averaged 8 percent per year more than the return on a short-term treasury bill. The predictability of time variation in returns is modest at high frequencies (about 10 percent of the variation in returns one quarter ahead is predictable) and quite large over longer periods (just under half of the variation in returns over five-year periods is predictable). Finally, portfolios based on the intersection of quintiles of stocks ranked by market value and by the ratio of book value to market value have differences in average annual returns across stocks of several percent per year. The natural explanation for these variations in returns is risk. But variations in consumption risk have done a poor job of explaining these differences in expected returns (see e.g., Sanford J. Grossman and Robert J. Shiller, 1981; Shiller, 1982; Lars Peter Hansen and Kenneth J. Singleton, 1983; N. Gregory Mankiw and Mat

OVER THE PAST century in the United States, the average annual return on the stock market has exceeded that on short-term government bonds by 6 percentage points. The natural economic explanation for the premium on equity is the greater risks associated with investing in the stock market. However, the large premium that we observe cannot be explained by the canonical, consumption-based asset pricing model. Risk is best measured as the extent to which a return alters marginal utility. Since marginal utility is closely related to consumption, and consumption moves little with returns, the measured risk of the stock market is small. (1) One common informal interpretation of this equity premium puzzle is that stocks are a good deal. In this view, the model is taken as a reasonably accurate description of optimal behavior and a poor description of actual behavior. This normative view of the model and the data implies that households should increase their holdings of equity and even borrow to invest in the stock market. (2) Such thinking has also entered important areas of public policy, most notably in proposals to allow funds from the Social Security system--whether the current $1 trillion surplus in the trust fund or the entire $10 trillion in implicit liabilities--to be invested in the stock market rather than entirely in government bonds as is currently done. The positive view of the equity premium puzzle is that we simply do not understand asset prices. Since the puzzle was discovered, economists' efforts to find a model that rationalizes the premium have yielded little success. That is, there is as yet no model of a household investment problem with reasonable levels of risk aversion that explains the variation in returns over time, and the difference in returns between stocks and bonds in particular. This leaves economists largely unable to model investment behavior and largely unable to provide policymakers with guidance for the diversification of the Social Security system. This paper proposes an understanding of the risk-return trade-off between stocks and bonds that departs from the canonical model in two ways. First, I ignore many issues in asset pricing and focus solely on the ultimate risk to consumption of a given portfolio choice. That is, rather than measure the risk to consumption as the contemporaneous response of consumption to returns on the stock market, this paper measures the risk as the medium-term impact of stock market returns on consumption. (3) Second, in addition to studying the medium-term risk of equity as measured by aggregate consumption data, I follow Gregory Mankiw and Stephen Zeldes and ask whether the risk of equity justifies its return for the subset of households that hold equity. (4) The main finding of the paper is that the medium-term risk of equity is much greater than the contemporaneous risk, both for the representative household and for the representative stock. holder. For households that hold equity, the medium-term risk is largely sufficient to justify the high relative return of equity. Measuring the risk of equity as the medium-term impact of a return on consumption has several appealing features. First, this approach maintains the assumption that the primary determinant of utility is the level of consumption. This assumption is intuitive and has proved useful and successful in many other branches of economics. Second, this approach is consistent with the theory of portfolio choice in that the medium-term risk and the contemporaneous risk should be approximately the same according to the canonical model. Most important, the medium-term risk is a better measure of the true risk of the stock market under a wide class of extant models used in the study of household consumption and saving. If consumption responds with a lag to changes in wealth, then the contemporaneous covariance of consumption and wealth understates the risk of equity, and the medium-term risk provides the correct measure. …

Human beings want to believe that good outcomes in the future are more likely, but also want to make good decisions that increase average outcomes in the future. We consider a general equilibrium model with complete markets and show that when investors hold beliefs that optimally balance these two incentives, portfolio holdings and asset prices match six observed patterns: (i) because the cost of biased beliefs are typically second-order, investors typically hold biased assessments of probabilities and so are not perfectly diversified according to objective metrics; (ii) because the costs of biased beliefs temper these biases, the utility costs of the lack of diversification are limited; (iii) because there is a complementarity between believing a state more likely and purchasing more of the asset that pays off in that state, investors over-invest in only one Arrow-Debreu security and smooth their consumption well across the remaining states; (iv) because different households can settle on different states to be optimistic about, optimal portfolios of ex ante identical investors can be heterogeneous; (v) because low-price and low-probability states are the cheapest states to buy consumption in, overoptimism about these states distorts consumption the least in the rest of the states, so that investors tend to overinvest in the most skewed securities; (vi) finally, because investors with optimal expectations have higher demand for more skewed assets, ceteris paribus, more skewed asset can have lower average returns.

This paper argues that taxation of retained profits is particularly distortionary in an economy with good growth prospects and poorly developed financial markets because it primarily reduces the investment of financially constrained firms, investment that has marginal product greater than the after-tax market real interest rate. Contrarily, taxes on distributed profits or capital gains primarily reduce the investment of financially unconstrained firms. Chile experienced a banking crisis over the period from 1982 to 1986 and in 1984 reduced its tax rate on retained profits from 50 percent to 10 percent. We show that, consistent with our theory, there was a large increase in aggregate investment after the reform which was entirely funded by an increase in retained profits. Further, we show that investment grew by more in industries that depend more on external financing, according to the Rajan and Zingales (1998) measure. Finally, we present some weak evidence from comparisons of investment rates across firms for several different measures of their likelihood of being financially constrained.

This paper argues that taxation of retained profits is particularly distortionary in an economy with good growth prospects and poorly developed financial markets because it primarily reduces the investment of financially constrained firms, investment that has marginal product greater than the after-tax market real interest rate. Contrarily, taxes on distributed profits or capital gains primarily reduce the investment of financially unconstrained firms. Chile experienced a banking crisis over the period from 1982 to 1986 and in 1984 reduced its tax rate on retained profits from 50 percent to 10 percent. We show that, consistent with our theory, there was a large increase in aggregate investment after the reform which was entirely funded by an increase in retained profits. Further, we show that investment grew by more in industries that depend more on external financing, according to the Rajan and Zingales (1998) measure. Finally, we present some weak evidence from comparisons of investment rates across firms for several different measures of their likelihood of being financially constrained.

This paper introduces a tractable, structural model of subjective beliefs. Since agents that plan for the future care about expected future utility flows, current felicity can be increased by believing that better outcomes are more likely. On the other hand, expectations that are biased towards optimism worsen decision making, leading to poorer realized outcomes on average. Optimal expectations balance these forces by maximizing the total well-being of an agent over time. We apply our framework of optimal expectations to three different economic settings. In a portfolio choice problem, agents overestimate the return of their investment and underdiversify. In general equilibrium, agents' prior beliefs are endogenously heterogeneous, leading to gambling. Second, in a consumption-saving problem with stochastic income, agents are both overconfident and overoptimistic, and consume more than implied by rational beliefs early in life. Third, in choosing when to undertake a single task with an uncertain cost, agents exhibit several features of procrastination, including regret, inter-temporal preference reversal, and a greater readiness to accept commitment.

During the past two decades, the personal saving rate in the United States has fallen from eight percent to below zero. This paper demonstrates that this change represents a major shift in the allocation of newly produced goods. The share of GDP that households consume rose by 6 percentage points since 1980. This increase occurred concurrently with a reduction in the growth rate of real consumption spending per person, high real rates of return, and an increasing ratio of aggregate wealth to income. Despite this last fact, wealth changes can explain little of the boom in consumption spending. The largest increases in national wealth post-date the consumption boom and households with different wealth levels have similar increases in consumption. The paper also finds that the changing age distribution of the U.S. population does not explain the consumption boom. While it may be that new wealthier cohorts are driving this boom, the preponderance of evidence suggest rather that the rising consumption to income ratio is due to a common time effect. The main findings of the paper are consistent with either an increase in the discount rate or with a general belief in better economic times in the future. Alternatively, the low rates of saving could be due to a combination of factors such as the increase in intergenerational transfers from the Social Security system raising the consumption of the elderly and an increase in access to credit and expanded financial instruments raising the consumption of the young.

During the past two decades, the personal saving rate in the United States has fallen from 8% to below zero, and the share of GDP that households consume rose by 6 percentage points. This increase in the share of consumption was concurrent with a reduction in the growth rate of real consumption spending per person, high real rates of return, and an increasing ratio of aggregate wealth to income. Despite this last fact, wealth changes can explain little of the boom in consumption spending: The largest increases in national wealth postdate the consumption boom, and households with differing wealth levels nevertheless had similar increases in consumption. The changing age distribution of the U.S. population does not explain the consumption boom, either: While it may be that younger, wealthier cohorts are driving this boom, the preponderance of evidence suggests rather that the rising consumption-to-income ratio is due to a common time effect. The main findings of the paper are consistent with either an incre...