Pseudo-Wealth and Consumption Fluctuations
37 Pages Posted: 21 Nov 2016
Date Written: November 2016
This paper provides an explanation for situations in which the state variables describing the economy do not change, but aggregate consumption experiences significant changes. We present a theory of pseudo-wealth—individuals’ perceived wealth that is derived from heterogeneous beliefs and expectations of gains in a bet. This wealth is divorced from real assets that may exist in society. The creation of a market for bets will imply positive pseudo-wealth. Changes in the differences of prior beliefs will lead to changes in expected wealth and hence to changes in consumption, implying ex-post intertemporal individual and aggregate consumption misallocations and instabilities. Thus, in the environment we describe, completing markets increases macroeconomic volatility, raising unsettling welfare questions.
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