Temptation and Commitment: A Model of Hand-to-Mouth Behavior
57 Pages Posted: 14 Oct 2020 Last revised: 10 May 2023
Date Written: October 2020
Abstract
This paper presents a model of consumption behavior that explains the presence of ‘wealthy hand-to-mouth’ consumers using a mechanism that differs from those analyzed previously. We show that a two-asset model with temptation preferences generates a demand for commitment and thus illiquidity, leading to hand-to-mouth behavior even when liquid assets deliver higher returns than illiquid assets. This preference for illiquidity has important implications for consumption behaviour and for fiscal stimulus policies. Our model matches the recent empirical evidence that MPCs remain high even for large income shocks, suggesting a larger response to targeted fiscal stimulus than previously believed.
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