Macroeconomic implications of dynamically inconsistent preferences

Despite the widespread use of models of intertemporal choices in economics, previous studies have assumed that intertemporal preferences are dynamically consistent. This paper provides a fresh perspective on propagation mechanisms of a typical macroeconomic shock in a model with dynamically inconsistent preferences. To this end, I develop a prototypical neoclassical model that features dynamically inconsistent preferences to explore dynamic responses of key macro-aggregates, discounted cumulative effects and some characteristics of aggregate fluctuations in response to a technology shock. The main findings reveal that (a) consumption and investment in the proposed model show a larger increase than those in a standard neoclassical model; (b) unlike the standard model, the proposed model yields a short-run decline in labor, which is corroborated by previous studies; (c) all of these dynamic responses in the proposed model deliver smaller cumulative output effects; (d) the proposed model does a reasonably good job of matching key characteristics of aggregate fluctuations with the counterparts observed in the postwar U.S. data. The present-bias and sophistication effects are the linchpin of these main results. Various analyses on a set of different parameter values are also discussed.