Quick-Fixing: Near-Rationality in Consumption and Savings Behavior

66 Pages Posted: 28 Oct 2024

See all articles by Peter Andre

Peter Andre

Leibniz Institute for Financial Research SAFE; Goethe University Frankfurt

Joel P. Flynn

Yale University

Georgios Nikolakoudis

Princeton University

Karthik Sastry

Princeton University - Department of Economics

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Date Written: October 25, 2024

Abstract

The near-rationality hypothesis holds that even very small costs of optimization may lead people to act suboptimally. We embed this idea in a standard model of consumption-savings decisions: households pursue simple quick-fix consumption policies unless they pay a cost to optimize. We design a novel survey to explore this theory. The survey elicits households' hypothetical consumption responses to a large number of unanticipated income shocks, allowing us to estimate household-level consumption policies. Consistent with the theory, 68% of households follow one of four simple quick-fix consumption rules that either fully consume or fully save out of small shocks before abruptly switching to similar consumption policies for large shocks. Households' quick-fixing types account for 49% of the variance in MPCs across households, despite not being predictable by other demographic and economic information. Quantitatively, an incomplete-markets model calibrated to our survey findings generates more than three times as much size-dependence in the aggregate consumption response to government transfer shocks as the nested rational model. This large difference in behavior arises while households experience consumption-equivalent welfare costs of near-rationality of at most $65 per quarter.

Suggested Citation

Andre, Peter and Flynn, Joel P. and Nikolakoudis, Georgios and Sastry, Karthik, Quick-Fixing: Near-Rationality in Consumption and Savings Behavior (October 25, 2024). Available at SSRN: https://ssrn.com/abstract=4999497 or http://dx.doi.org/10.2139/ssrn.4999497

Peter Andre

Leibniz Institute for Financial Research SAFE ( email )

House of Finance
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Goethe University Frankfurt

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Joel P. Flynn (Contact Author)

Yale University ( email )

493 College St
New Haven, CT CT 06520
United States

Georgios Nikolakoudis

Princeton University ( email )

Julis Romo Rabinowitz Building
Princeton, NJ 08544
United States
6093563619 (Phone)

Karthik Sastry

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

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