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Short-term planning and the life-cycle consumption puzzle

  • Caliendo, Frank
  • Aadland, David

This paper provides a new explanation for the hump-shaped age- consumption profile observed in household data. Standard life-cycle models are based on an optimization problem that spans the entire life expectancy. Alternatively, we examine the consumption profile of an individual with a shorter planning horizon. The actual consumption profile is the envelope of a continuum of control problems because the agent’s short-term planning horizon continually slides along the time- scale, and the agent is therefore continually re-optimizing. We derive analytical solutions to a deterministic, continuous-time control model with this characteristic and we show that hump-shaped consumption is a feature of the model.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 31 (2007)
Issue (Month): 4 (April)
Pages: 1392-1415

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Handle: RePEc:eee:dyncon:v:31:y:2007:i:4:p:1392-1415
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