Exponential-Growth Bias in Experimental Consumption Decisions

65 Pages Posted: 1 Jun 2015 Last revised: 6 Oct 2015

See all articles by Matthew Levy

Matthew Levy

London School of Economics & Political Science (LSE) - Department of Economics

Joshua Tasoff

Claremont Colleges - Claremont Graduate University

Date Written: September 29, 2015

Abstract

Exponential-growth bias (EGB) is the tendency to neglect the power of compounding inter- est. A person with EGB will misperceive the intertemporal budget constraint, overestimating lifetime wealth and underestimating the differences in the cost of consumption across periods . We test four comparative static predictions implied by EGB: (1) compound interest will increase consumption, (2) budget-neutral delays in income will increase consumption, (3) the person will exhibit a form of dynamic inconsistency that depends solely on the current account balance and is independent of time preferences, and (4) framing the frequency of interest in shorter units increases consumption. We test these predictions using an induced-value consumption-savings experiment in the lab, and find evidence in support of all predictions against the rational bench- mark. People may use rules of thumb when making consumption-savings decisions. We consider three rules of thumb as alternative hypotheses and find that they cannot explain the results.

Keywords: exponential-growth bias, dynamic inconsistency, overconsumption, consumption- savings, personal finance

JEL Classification: D03, D14, D91

Suggested Citation

Levy, Matthew and Tasoff, Joshua, Exponential-Growth Bias in Experimental Consumption Decisions (September 29, 2015). Available at SSRN: https://ssrn.com/abstract=2612749 or http://dx.doi.org/10.2139/ssrn.2612749

Matthew Levy

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Joshua Tasoff (Contact Author)

Claremont Colleges - Claremont Graduate University ( email )

150 E. Tenth Street
Claremont, CA 91711
United States

HOME PAGE: http://sites.cgu.edu/tasoffj/

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