Rules of Thumb in Life‐Cycle Saving Decisions

Abstract:     
We analyse life‐cycle saving decisions when households use simple heuristics, or rules of thumb, rather than solve the underlying intertemporal optimisation problem. We simulate life‐cycle saving decisions using three simple rules and compute utility losses relative to the solution of the optimisation problem. Our simulations suggest that utility losses induced by following simple decision rules are relatively low. Moreover, the two main saving motives reflected by the canonical life‐cycle model – long‐run consumption smoothing and short‐run insurance against income shocks – can be addressed quite well by saving rules that do not require computationally demanding tasks, such as backwards induction.

Number of Pages in PDF File: 23

Accepted Paper Series