Passive Decisions and Potent Defaults

Abstract:     
Default options have an enormous impact on household 'choices.' Defaults matter because opting out of a default is costly and these costs change over time, generating an option value of waiting. In addition, people have a tendency to procrastinate. We develop a theory of optimal defaults based on these considerations. We find that it is sometimes optimal to set extreme defaults, which are far away from the mean optimal savings rate. A default that is far away from a consumer's optimal savings rate may make that consumer better off since such a 'bad' default will lead procrastinating consumers to more quickly opt out of the default. We calibrate our model and use it to calculate optimal defaults for employees at four different companies. Our work suggests that optimal defaults are likely to be at one of three savings rates: the minimum savings rate (i.e., 0%), the match threshold (typically 5% or 6%), or the maximal savings rate.

JEL Classifications: D1

Working Paper Series